Robust Optimization of Currency Portfolios

Raquel Fonseca, Steve Zymler, Wolfram Wiesemann and Berc Rustem

No 12, Working Papers from COMISEF

Abstract: We study a currency investment strategy, where we maximize the return on a portfolio of foreign currencies relative to any appreciation of the corresponding foreign exchange rates. Given the uncertainty in the estimation of the future currency values, we employ robust optimization techniques to maximize the return on the portfolio for the worst-case foreign exchange rate scenario. Currency portfolios differ from stock only portfolios in that a triangular relationship exists among foreign exchange rates to avoid arbitrage. Although the inclusion of such a constraint in the model would lead to a nonconvex problem, we show that by choosing appropriate uncertainty sets for the exchange and the cross exchange rates, we obtain a convex model that can be solved efficiently. Alongside robust optimization, an additional guarantee is explored by investing in currency options to cover the eventuality that foreign exchange rates materialize outside the specified uncertainty sets. We present numerical results that show the relationship between the size of the uncertainty sets and the distribution of the investment among currencies and options, and the overall performance of the model in a series of backtesting experiments.

Keywords: robust optimization; portfolio optimization; currency hedging; second-order cone programming (search for similar items in EconPapers)
Pages: 20 pages
Date: 2009-08-26
New Economics Papers: this item is included in nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

Downloads: (external link)
http://comisef.eu/files/wps012.pdf (application/pdf)
Our link check indicates that this URL is bad, the error code is: 500 Can't connect to comisef.eu:80 (A connection attempt failed because the connected party did not properly respond after a period of time, or established connection failed because connected host has failed to respond.)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:com:wpaper:012

Access Statistics for this paper

More papers in Working Papers from COMISEF
Bibliographic data for series maintained by Anil Khuman ().