CVaR models with selective hedging for international asset allocation

We develop an integrated simulation and optimization framework for multicurrency asset allocation problems. The simulation applies principal component analysis to generate scenarios depicting the discrete joint distributions of uncertain asset returns and exchange rates. We then develop and implemen...

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Veröffentlicht in:	Journal of banking & finance Jg. 26; H. 7; S. 1535 - 1561
Hauptverfasser:	Topaloglou, Nikolas, Vladimirou, Hercules, Zenios, Stavros A.
Format:	Journal Article
Sprache:	Englisch
Veröffentlicht:	Amsterdam Elsevier B.V 01.07.2002 Elsevier Elsevier Sequoia S.A
Schriftenreihe:	Journal of Banking & Finance
Schlagworte:	Allocation Asset allocation Assets Currency hedging Diversification Financial economics Foreign exchange rates Hedges Hedging International asset allocation International finance Investment Investment returns Mathematical models Measurement Optimization Portfolio selection Portfolios Principal components analysis Risk Risk assessment Risk management Simulation Statistical methods Stochastic programming models Studies C44 Currency hedging G34 Stochastic programming models International asset allocation D81 Risk management C61
ISSN:	0378-4266, 1872-6372
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Abstract	We develop an integrated simulation and optimization framework for multicurrency asset allocation problems. The simulation applies principal component analysis to generate scenarios depicting the discrete joint distributions of uncertain asset returns and exchange rates. We then develop and implement models that optimize the conditional-value-at-risk (CVaR) metric. The scenario-based optimization models encompass alternative hedging strategies, including selective hedging that incorporates currency hedging decisions within the portfolio selection problem. Thus, the selective hedging model determines jointly the portfolio composition and the level of currency hedging for each market via forward exchanges. We examine empirically the benefits of international diversification and the impact of hedging policies on risk–return profiles of portfolios. We assess the effectiveness of the scenario generation procedure and the stability of the model's results by means of out-of-sample simulations. We also compare the performance of the CVaR model against that of a model that employs the mean absolute deviation (MAD) risk measure. We investigate empirically the ex post performance of the models on international portfolios of stock and bond indices using historical market data. Selective hedging proves to be the superior hedging strategy that improves the risk–return profile of portfolios regardless of the risk measurement metric. Although in static tests the MAD and CVaR models often select portfolios that trace practically indistinguishable ex ante risk–return efficient frontiers, in successive applications over several consecutive time periods the CVaR model attains superior ex post results in terms of both higher returns and lower volatility.
AbstractList	We develop an integrated simulation and optimization framework for multicurrency asset allocation problems. The simulation applies principal component analysis to generate scenarios depicting the discrete joint distributions of uncertain asset returns and exchange rates. We then develop and implement models that optimize the conditional-value-at-risk (CVaR) metric. The scenario-based optimization models encompass alternative hedging strategies, including selective hedging that incorporates currency hedging decisions within the portfolio selection problem. Thus, the selective hedging model determines jointly the portfolio composition and the level of currency hedging for each market via forward exchanges. We examine empirically the benefits of international diversification and the impact of hedging policies on risk–return profiles of portfolios. We assess the effectiveness of the scenario generation procedure and the stability of the model's results by means of out-of-sample simulations. We also compare the performance of the CVaR model against that of a model that employs the mean absolute deviation (MAD) risk measure. We investigate empirically the ex post performance of the models on international portfolios of stock and bond indices using historical market data. Selective hedging proves to be the superior hedging strategy that improves the risk–return profile of portfolios regardless of the risk measurement metric. Although in static tests the MAD and CVaR models often select portfolios that trace practically indistinguishable ex ante risk–return efficient frontiers, in successive applications over several consecutive time periods the CVaR model attains superior ex post results in terms of both higher returns and lower volatility. This study develops an integrated simulation and optimization framework for multicurrency asset allocation problems. The simulation applies principal component analysis to general scenarios depicting the discrete joint distributions of uncertain asset returns and exchange rates. It then develops and implements models that optimize the conditional-value-at-risk metric. It examines empirically the benefits of international diversification and the impact of hedging policies on risk-return profiles of portfolios. It assesses the effectiveness of the scenario generation procedure and the stability of the model's results by means of out-of-sample simulations. It also compares the performance of the CVaR model against that of a model that employs the mean absolute deviation risk measure. Selective hedging proves to be the superior hedging strategy that improves the risk-return profit of portfolios regardless of the risk measurement metric.
Author	Topaloglou, Nikolas Zenios, Stavros A. Vladimirou, Hercules
Author_xml	– sequence: 1 givenname: Nikolas surname: Topaloglou fullname: Topaloglou, Nikolas – sequence: 2 givenname: Hercules surname: Vladimirou fullname: Vladimirou, Hercules email: hercules@ucy.ac.cy – sequence: 3 givenname: Stavros A. surname: Zenios fullname: Zenios, Stavros A.
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Cites_doi	10.1007/PL00011399 10.1111/1467-9965.00068 10.2307/2329070 10.2469/faj.v48.n4.37 10.3905/jpm.1989.409221 10.2307/2328798 10.2469/faj.v44.n3.45 10.1086/296296 10.2307/2328331 10.2307/2331042 10.3905/jpm.1998.409648 10.21314/JOR.2000.038 10.1108/eb043481 10.1287/mnsc.37.5.519 10.1016/S0378-4266(02)00271-6
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SubjectTerms	Allocation Asset allocation Assets Currency hedging Diversification Financial economics Foreign exchange rates Hedges Hedging International asset allocation International finance Investment Investment returns Mathematical models Measurement Optimization Portfolio selection Portfolios Principal components analysis Risk Risk assessment Risk management Simulation Statistical methods Stochastic programming models Studies
Title	CVaR models with selective hedging for international asset allocation
URI	https://dx.doi.org/10.1016/S0378-4266(02)00289-3 http://econpapers.repec.org/article/eeejbfina/v_3a26_3ay_3a2002_3ai_3a7_3ap_3a1535-1561.htm https://www.proquest.com/docview/194915280 https://www.proquest.com/docview/39149841
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