Weak Interest Rate Parity and Currency Portfolio Diversification
This paper presents a dynamic model of optimal currency returns with a hidden Markov regime switching process. We postulate a weak form of interest rate parity that the hedged risk premiums on currency investments are identical within each regime across all currencies. Both the in-sample and the out-ofsample data during January 2002 - March 2005 strongly support this hypothesis. Observing past asset returns, investors infer the prevailing regime of the economy and determine the most likely future direction to facilitate portfolio decisions. Using standard mean variance analysis, we find that an optimal portfolio resembles the Federal Exchange Rate Index which characterizes the strength of the U.S. dollar against world major currencies. The similarity provides a strong implication that our three-regime switching model is appropriate for modeling the hedged returns in excess of the U.S. risk free interest rate. To investigate the impact of the equity market performance on changes of exchange rates, we include the S&P500 index return as an exogenous factor for parameter estimation.
Leonard C. MacLean Yonggan Zhao William T. Ziemba
School of Business Administration, Dalhousie University, Halifax, NS, Canada, B3H 3J5. Division of Banking and Finance, Nanyang Business School, Nanyang Technological University,Singapore Sauder School of Business, University of British Columbia, Canada, V6T 1Z2, and SloanSchool of Manag
国际会议
西安
英文
2006-07-17（万方平台首次上网日期，不代表论文的发表时间）