Beyond the Carry Trade: Optimal Currency Portfolios
Abstract
We test the relevance of technical and fundamental variables in forming currency portfolios. Carry, momentum and reversal all contribute to portfolio performance, whereas the real exchange rate and the current account do not. The resulting optimal portfolio produces out-of-sample returns that are not explained by risk and are valuable to diversified investors holding stocks and bonds. Exposure to currencies increases the Sharpe ratio of diversified portfolios by 0.5 on average, while reducing crash risk. The profitability of our optimal strategy decreases with the amount of assets under management by hedge funds, consistent with the adaptive markets hypothesis. We argue that besides risk, currency returns reflect the scarcity of speculative capital.
This event is an Erasmus Finance Seminar. The Erasmus Finance Seminar series brings prominent researchers in Finance from all over the world to Rotterdam.
