Currency exposure optimization in international bond portfolios

Abstract

In the context of international bond markets, in an application of Barroso et al. (2021)’s use of Parametric Portfolio Policies (PPP) to optimize the currency component of an international equities portfolio, I find evidence that deviating from fully hedging currency exposure can benefit a US investor. Internationalizing would be optimal since a domestic bond portfolio would have underperformed an equal-weighted international bond portfolio during the observation period from April 1988 to December 2020. In an analysis that captures transaction and rebalancing costs, as well as margin requirements, the PPP produces an increase in Sharpe Ratio in relation to a full hedged benchmark across models of 80% and 20%, on average, for tracking errors of 2% and 0.5%, respectively. The PPP overlay strategy generates statistically significant Jensen-α and Information ratio improvements from the full hedged benchmark and is robust in enhancing its performance using different tracking errors, risk aversion levels and benchmarks.

Date of Award	2 Feb 2022
Original language	English
Awarding Institution	Universidade Católica Portuguesa
Supervisor	Pedro Barroso (Supervisor)