Exchange Rate Uncertainty, Forward Contracts, and International Portfolio Selection

Exchange Rate Uncertainty, Forward Contracts, and International Portfolio Selection ABSTRACT In this paper, ex ante efficient portfolio selection strategies are developed to realize potential gains from international diversification under flexible exchange rates. It is shown that exchange rate uncertainty is a largely nondiversifiable factor adversely affecting the performance of international portfolios. Therefore, it is essential to effectively control exchange rate volatility. For that purpose, two methods of exchange risk reduction are simultaneously employed: multicurrency diversification and hedging via forward exchange contracts. The empirical findings show that international portfolio selection strategies designed to control both estimation and exchange risks almost consistently outperform the U.S. domestic portfolio in out‐of‐sample periods. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Journal of Finance Wiley

Exchange Rate Uncertainty, Forward Contracts, and International Portfolio Selection

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Publisher
Wiley Subscription Services, Inc., A Wiley Company
Copyright
1988 The American Finance Association
ISSN
0022-1082
eISSN
1540-6261
D.O.I.
10.1111/j.1540-6261.1988.tb02597.x
Publisher site
See Article on Publisher Site

Abstract

ABSTRACT In this paper, ex ante efficient portfolio selection strategies are developed to realize potential gains from international diversification under flexible exchange rates. It is shown that exchange rate uncertainty is a largely nondiversifiable factor adversely affecting the performance of international portfolios. Therefore, it is essential to effectively control exchange rate volatility. For that purpose, two methods of exchange risk reduction are simultaneously employed: multicurrency diversification and hedging via forward exchange contracts. The empirical findings show that international portfolio selection strategies designed to control both estimation and exchange risks almost consistently outperform the U.S. domestic portfolio in out‐of‐sample periods.

Journal

The Journal of FinanceWiley

Published: Mar 1, 1988

References

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