International Equity Portfolios Research Articles

When Bonds Matter: Home Bias in Goods and Assets

Recent models of international equity portfolios exhibit two potential weaknesses: 1) the structure of equilibrium equity portfolios is determined by the correlation of equity returns with real exchange rates; yet empirically equities don't appear to be a good hedge against real exchange rate risk; 2) Equity portfolios are highly sensitive to preference parameters. This paper solves both problems. It first shows that in more general and realistic environments, the hedging of real exchange rate risks occurs through international bond holdings since relative bond returns are strongly correlated with real exchange rate fluctuations. Equilibrium equity positions are then optimally determined by the correlation of equity returns with the return on non-financial wealth, conditional on the bond returns. The model delivers equilibrium portfolios that are well-behaved as a function of the underlying preference parameters. We find reasonable empirical support for the theory for G-7 countries. We are able to explain short positions in domestic currency bonds for all G-7 countries, as well as significant levels of home equity bias for the US, Japan and Canada.

Small caps in international equity portfolios: the effects of variance risk

We show that predictable covariances between means and variances of stock returns may have a first order effect on portfolio composition. In an international asset menu that includes both European and North American small capitalization equity indices, we find that a three-state, heteroskedastic regime switching VAR model is required to provide a good fit to weekly return data and to accurately predict the dynamics in the joint density of returns. As a result of the non-linear dynamic features revealed by the data, small cap portfolios become riskier in bear markets, i.e., display negative co-skewness with other stock indices. Because of this property, a power utility investor ought to hold a well-diversified portfolio, despite the high risk premium and Sharpe ratios offered by small capitalization stocks. On the contrary, small caps command large optimal weights when the investor ignores variance risk, by incorrectly assuming joint normality of returns.

Currency Investing in Global Portfolios: Hedging or Speculative Benefits?

This paper investigates whether and how currency strategies can enhance the performance of international bond and equity portfolios. Currency positions may deliver hedging benefits, pure investment, i.e. speculative benefits, or both simultaneously. We develop a new test that decomposes the total change in Sharpe ratio resulting from adding currency positions to any risky portfolio, into the share due to hedging and the share due to speculative benefits of currencies. This allows us to identify, measure and compare economically and statistically these two sources of value added. Based on stock and bond returns from 12 developed countries between 1975 and 2007, we find that adding currency deposits to international equity or bond portfolios significantly enhances their performance, leading to a doubling of their Sharpe ratios. Our decomposition shows that, while economically non-negligible, the hedging benefits of currency positions are not statistically significant. Most of the performance enhancement delivered by currency positions can be attributed to their speculative benefits, which are both economically large and highly statistically significant. These results are robust for various static and dynamic investment strategies and for investors with different home currencies.

SYMMETRIC VERSUS ASYMMETRIC CONDITIONAL COVARIANCE FORECASTS: DOES IT PAY TO SWITCH?

AbstractVolatilities and correlations for equity markets rise more after negative returns shocks than after positive shocks. Allowing for these asymmetries in covariance forecasts decreases mean‐variance portfolio risk and improves investor welfare. We compute optimal weights for international equity portfolios using predictions from asymmetric covariance forecasting models and a spectrum of expected returns. Investors who are moderately risk averse, have longer rebalancing horizons, and hold U.S. equities benefit most and may be willing to pay around 100 basis points annually to switch from symmetric to asymmetric forecasts. Accounting for asymmetry in both variances and correlations significantly lowers realized portfolio risk.

Performance of Portfolios Optimized with Estimation Error

We explain the poor out-of-sample performance of mean-variance optimized portfolios, developing theoretical bias adjustments for estimation risk by asymptotically expanding future returns of portfolios formed with estimated weights. We provide closed-form non-Bayesian adjustments of classical estimates of portfolio mean and standard deviation. The adjustments significantly reduce bias in international equity portfolios, increase economic gains, and are robust to sample size and to nonnormality. Dominant terms grow linearly with the number of assets and decline inversely with the number of past time periods. Under suitable conditions, Sharpe-ratio maximizing tangency portfolios become more diversified. Using these approximation methods it may be possible to assess, before investing, the effect of statistical estimation error on portfolio performance.

International Equity Indices

We provide evidence that for the developed markets that were part of the MSCI EAFE index over the 1970–2004 period, an equally-weighted index outperforms market-cap and GDP-weighted indices. Two important characteristics distinguish the equally-weighted index from its counterparts: lower concentration and more frequent rebalancing. We simulate international equity portfolios along these two dimensions. Lower concentrated portfolios almost systematically dominate more concentrated portfolios. Though rebalancing dominates no rebalancing, the relation between international portfolios rebalanced according to different frequencies is more tenuous. <b>TOPICS:</b>Mutual funds/passive investing/indexing, developed markets, equity portfolio management

Institutional Determinants of International Equity Portfolios - A Country-Level Analysis

Despite large potential gains, international equity investment is less diversified across countries than predicted by the international version of the traditional capital asset pricing model (ICAPM). This paper provides empirical evidence on the impact of capital market frictions on international equity portfolios using data on bilateral equity holdings. Two important findings are reported: First, besides a home bias in equities, a 'friendship bias' can be observed for some country pairs. Second, indirect barriers such as the degree of financial market development and especially information asymmetries have strong explanatory power, whereas direct barriers such as capital flow restrictions have no impact on the portfolio share of foreign equities.

Small Caps in International Equity Portfolios: The Effects of Variance Risk

We show that predictable covariances between means and variances of stock returns may have a first order effect on portfolio composition. In an international asset menu that includes both European and North American small capitalization equity indices, we find that a three-state, heteroskedastic regime switching VAR model is required to provide a good fit to weekly return data and to accurately predict the dynamics in the joint density of returns. As a result of the non-linear dynamic features revealed by the data, small cap portfolios become riskier in bear markets, i.e. display negative co-skewness with other stock indices. Because of this property, a power utility investor ought to hold a well diversified portfolio, despite the high risk premium and Sharpe ratios offered by small capitalization stocks. On the contrary small caps command large optimal weights when the investor ignores variance risk, by incorrectly assuming joint normality of returns. These results provide the missing partial equilibrium rationale for the presence of co skewness in the empirical asset pricing models that have been proposed to explain the cross-section of stock returns.

Institutional Determinants of International Equity Portfolios - A Country-Level Analysis

Despite large potential gains international equity investment is less diversified across countries than predicted by the international version of the classical capital asset pricing model (ICAPM). This paper provides empirical evidence on the impact of capital market frictions on international equity portfolios using data on bilateral equity holdings. Three important findings are reported: First, the home bias in equities puzzle does not exist for all observed country pairs, instead a 'friendship bias' can be observed. Second, indirect barriers such as the degree of financial market development and especially information asymmetries have strong explanatory power, whereas direct barriers such as taxes and capital controls have almost no impact on the portfolio share of foreign equities. Third, diversification motives have an impact on the relevance of capital market frictions.

International Equity Portfolios and Currency Hedging: The Viewpoint of German and Hungarian Investors

AbstractIn this paper we study the benefits derived from international diversification of equity portfolios from the German and the Hungarian points of view. In contrast to the German capital market, which is one of the largest in the world, the Hungarian Stock Exchange is an emerging market. The Hungarian stock market is highly volatile, high returns are often accompanied by extremely large risk. Therefore, there is a good potential for Hungarian investors to realise substantial benefits in terms of risk reduction by creating multi-currency portfolios. The paper gives evidence on the above mentioned benefits for both countries by examining the performance of several ex ante portfolio strategies. In order to control the currency risk, different types of hedging approaches are implemented.

A Dynamic Equilibrium Model of International Portfolio Holdings

This paper develops a continuous-time equilibrium model of a two-country exchange economy with heterogeneous agents and nontraded goods. Nontraded goods play the role of state variables that shift the marginal utility of traded goods. This affects prices and generates dynamic hedging demands that explain the well documented home bias puzzle in international equity portfolios. When calibrated to both consumption and production data, the model is able to generate significative home bias in equity portfolios. A new methodology, based on Malliavin calculus, is presented to solve for the portfolio policies along the equilibrium path. This methodology allows one to reduce the determination of equilibrium portfolio holdings to the solution of a linear algebraic system, rather than a partial differential equation.

Optimal hedging using cointegration

Cointegration is a time-series modelling methodology that has many applications to financial markets. When spreads are mean reverting, prices are cointegrated. Then a multivariate model will provide further insight into the price equilibria and returns causalities within the system. Spot–futures arbitrage, yield–curve modelling, index tracking and spread trading are some of the applications of cointegration that are reviewed in this paper. With the demand for new quantitative approaches to active investment management strategies there is considerable interest in cointegration theory. This paper presents a model of cointegrated international equity portfolios which is currently used for hedging within the European, Asian and Far East countries.

International Portfolio Investment Flows

ABSTRACTThis article develops a model of international equity portfolio investment flows based on differences in informational endowments between foreign and domestic investors. It is shown that when domestic investors possess a cumulative information advantage over foreign investors about their domestic market, investors tend to purchase foreign assets in periods when the return on foreign assets is high and to sell when the return is low. The implications of the model are tested using data on United States (U.S.) equity portfolio flows.

International Portfolio Investment Flows

This paper develops a model of International equity portfolio investment flows based on differences in informational endowments between foreign and domestic investors. It is shown that when domestic investors possess a cumulative information advantage over foreign investors about their domestic market, investors tend to purchase foreign assets in periods when the return on foreign assets is high and to sell when the return is low. The implications of the model are tested using data on US equity portfolio flows.

Socially Responsible Investing on a Global Basis

Travers discusses international socially responsible investing (SRI), focusing on managed portfolios that invest in firms that pass a screening test. He finds that international portfolios formed using social screens offer competitive returns when compared with unrestricted international portfolios. One problem with international SRI is that no benchmark exists to evaluate performance. Travers suggests that performance should be compared with the performance of peers from the universe of international managers who use SRI. He compiles such a universe and shows that its returns keep pace with those of the universe of unrestricted international equity portfolios.

A multivariate GARCH model of risk premia in foreign exchange markets

This paper investigates the existence of time-varying risk premia in deviations from uncovered interest parity based on the market capital asset pricing model. The empirical analysis is conducted using a broad data set of seven major currencies against the US dollar, and a world equity index in order to approximate the benchmark portfolio. The conditional covariance matrix of excess returns is modelled as a multivariate GARCH process. The results indicate significant conditional systematic risk. Estimated conditional beta coefficients are very similar across currencies and behave uniformly over time. The explanatory power of the model is significantly higher compared to the constant beta CAPM specification. Furthermore, estimation results suggest that (1) expected excess returns are less volatile in foreign exchange markets compared to stock markets, and (2) including nominal dollar assets in international equity portfolios can reduce overall portfolio risk.

The Japanese Weighting Decision in International Equity Portfolios

The Japanese Weighting Decision in International Equity Portfolios

Universal Hedging: Optimizing Currency Risk and Reward in International Equity Portfolios

Investors can increase their returns by holding foreign stocks in addition to domestic ones. They can also gain by taking the appropriate amount of exchange risk. But what amount is appropriate? Assume that investors see the world in light of their own consumption goods and count both risk and expected return when figuring their optimum hedges. Assume that they share common views on stocks and currencies and that markets are liquid and there are no barriers to international investing. In this perfect world, it is possible to derive a formula for the optimal hedge ratio. This formula requires three basic inputs—the average across countries of the expected returns on the world market portfolio; the average across countries of the volatility of the world market portfolio; and the average across all pairs of countries of exchange rate volatility. These values can be estimated from historical data. The formula, in turn, gives the circumstances for three rules. (1) Hedge foreign equity. (2) Hedge less than 100 ...

Universal Hedging: Optimizing Currency Risk and Reward in International Equity Portfolios

Universal Hedging: Optimizing Currency Risk and Reward in International Equity Portfolios

Influence of serum luteinising hormone concentrations on ovulation, conception, and early pregnancy loss in polycystic ovary syndrome.

Women with the polycystic ovary syndrome do not respond well to treatment with luteinising hormone releasing hormone. To determine whether this might be due to an underlying endocrine disturbance basal concentrations of luteinising hormone were measured in 54 infertile women treated with pulsatile luteinising hormone releasing hormone and concentrations at the time of maximum follicular growth were measured in 23 of the patients. Forty one patients ovulated. Forty one patients ovulated and 27 conceived, but nine pregnancies terminated within four weeks after ovulation. Basal luteinising hormone concentrations were significantly lower in those who conceived (12.4 (range 1.3-29.0) IU/l) than in those who did not (19.0 (3.5-50.0) IU/l) and in those whose pregnancy progressed (9.6 (1.3-29.0) IU/l) than in those with early loss of pregnancy (17.9 (7.0-29.0) IU/l). Concentrations at the time of maximum follicular growth were significantly lower in women who ovulated (9.4 (2.9-35.4) IU/l) than in those who did not (29.0 (7.0-50.0) IU/l) and in those who conceived (6.2 (2.9-8.5) IU/l) than in those who did not (17.9 (4.0-50.0) IU/l). These results indicate that high concentrations of luteinising hormone during the follicular phase in women with polycystic ovaries have a deleterious effect on rates of conception and may be a causal factor in early pregnancy loss.