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International Dynamic Asset Allocation and the Effect of the Exchange Rate

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  • Kristien Smedts

Abstract

This paper analyzes a stylized theoretical framework to examine optimal portfolio selection in an international context with an explicit focus on the effect of the exchange rate. More specifically, we study how the elimination of the exchange rate induces shifts in the optimal international portfolio. We show that the effect of the elimination of the exchange rate on the optimal portfolio is twofold. First, the volatility of the international portfolio changes (volatility effect of the exchange rate), and second, the national market prices of risk converge to common international market prices of risk (price effect of the exchange rate). This induces important shifts in the optimal international portfolio.

Suggested Citation

  • Kristien Smedts, 2004. "International Dynamic Asset Allocation and the Effect of the Exchange Rate," Working Papers Department of Economics ces0404, KU Leuven, Faculty of Economics and Business, Department of Economics.
  • Handle: RePEc:ete:ceswps:ces0404
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    Keywords

    International Financial Markets; Portfolio Diversification; Foreign Exchange.;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements

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