Foster-Hart optimization for currency portfolios

Kurosaki Tetsuo () and Kim Young Shin ()
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Kurosaki Tetsuo: Bank of Japan, 2-1-1 Nihonbashi-Hongokucho, Chuo-ku, Tokyo 103-8660, Japan
Kim Young Shin: Stony Brook University, College of Business, Stony Brook, NY 11794-3775, United States of America

Studies in Nonlinear Dynamics & Econometrics, 2019, vol. 23, issue 2, 15

Abstract: We examine the effectiveness of Foster-Hart optimization for currency portfolios. Compared to stock trading, short selling is quite common in currency trading. Combining long and short positions leads to maintaining positive expected portfolio returns. Foster-Hart optimization is more applicable to currency portfolios than to stock portfolios because the Foster-Hart risk measure is not defined for the gamble whose expected returns are negative. Our sample portfolio consists of ten European currencies. For time series analysis, we employ a generalized autoregressive conditional heteroscedasticity (GARCH) model with multivariate normal tempered stable (MNTS) distributed residuals in order to capture fat-tailedness, skewness, and asymmetric interdependence of exchange rate dynamics. Statistical tests indicate that the model is recommendable among the candidate models. We establish that Foster-Hart optimization is more profitable than standard techniques in this context.

Keywords: average value at risk; Foster-Hart risk; multivariate normal tempered stable distribution; portfolio optimization; value at risk (search for similar items in EconPapers)
JEL-codes: C13 C22 C52 C61 G11 (search for similar items in EconPapers)
Date: 2019
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DOI: 10.1515/snde-2017-0119

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