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Contribution Details

Type Working Paper
Scope Discipline-based scholarship
Title Optimal Currency Exposure Under Risk and Ambiguity Aversion
Organization Unit
  • Urban Ulrych
  • Nikola Vasiljevic
  • English
Institution University of Zurich
Series Name -
Number -
Date 2019
Abstract Text This paper addresses the choice of optimal currency exposure for a risk and ambiguity averse international investor. Robust mean-variance preferences, explicitly capturing an investor’s dislike for model uncertainty, are used in order to derive the model-free optimal currency exposure in the presence of both risk and ambiguity aversion. We show that the sample efficient currency demand can be expressed as a vector of generalized ridge regression coefficients of fully hedged portfolio returns on the excess currency returns. Moreover, the underlying model uncertainty corresponds to the penalty term in the regression. The empirical analysis of the derived currency overlay strategy employs the foreign exchange, stock, and bond returns over the period from 1999 to 2018. We find that our proposed hedging strategy leads to significant improvements of the portfolio performance and examine the effect of model uncertainty on optimal currency allocations.
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