Currency overlay portfolios Time-varying correlation (TVC)-GARCH model Hedging criterion Trend following strategy Cholesky decomposition
Incisive Risk Information Limited
TEE, K.-H., 2016. On optimising risk exposures with trend-following strategies in currency overlay portfolios. Journal of Investment Strategies, 6(1), pp.47-68.
This paper proposed an optimisation mechanism in the currency overlay portfolios construction process, an area that has not been explored in the literature that tend to focus on pre-determined fixed weights, such as the trading volume of currencies from the survey of the Bank for International Settlement, to construct overlay portfolios and may not always be optimal. This paper optimises the portfolio using the Cholesky Decomposition-based multivariate TVC (Time varying correlation)-GARCH and CC (Constant correlation) GARCH models as allocation schemes, with underlying currencies’ returns originated from a moving average-based trend following single FX strategy in a certain hedging criterion. This paper includes a FX strategy based on the equally weighted (average) of the three different single moving average days to determine hedging needs underlying the hedging criterion. The paper uses the returns of the strategies of EW (equally weighted)-TFX and TFX to construct the optimal currencies overlay portfolios. The findings reveal the EW-TFX portfolios with the TVC-GARCH scheme have the best risk-adjusted portfolio returns. There are some evidences on the significant differences of the portfolios' returns of the EW-TFX overlay portfolios with other currencies portfolios, hence supporting the outperformance. The findings also support existing evidence in the literature.
This paper was accepted for publication in Journal of Investment Strategies, it can be found at http://dx.doi.org/10.21314/JOIS.2016.078