The decision as to which Assets should be included in a portfolio is first addressed in a Strategic Asset Allocation policy. The determination of the Strategic Asset Allocation is one of the most important factors that influences a portfolio’s performance. The process of defining a policy within the Strategic Asset Allocation should be done by both the portfolio manager and the potential investor. Together with the International Capital Asset Pricing Model the Strategic Asset Allocation tries to find an optimal portfolio which maximizes return and, at the same time, tries to minimize the possible risk. Due to currency and inflation risk, hedging should be considered as crucial point during the Strategic Asset Allocation. 1 2 Strategic Asset Allocation under consideration of the International Capital Asset Pricing Model decides to which asset classes a portfolio should be divided. Factors which determine the decision are expected returns, variances and covariances as well as the degree of risk aversion.
The analysis of mean-variance which was mostly developed by Harry Markowitz gave portfolio advice until the early eighties concerning the optimal asset allocation. The aims of this approach were to minimize risk while receiving the highest possible return. Over the years the method was critized several times because of a lack of decisive factors. Markowitz only assumed a one period model and permanent income, currency and inflation risk were also ignored.3 Strategic Asset Allocation is much more than investing short- term. Investors care about inflation and currency risk. Hedging is particularly needed.
Inhaltsverzeichnis (Table of Contents)
- 1 Introduction
- 1.1 Goal of the paper and problem setting
- 1.2 Methodology
- 2 International Capital Asset Pricing Model
- 2.1 The model and assumptions
- 2.2 Diversifying internationally and the weaknesses of the model
- 2.3 The model of time varying returns in the International Capital Asset Pricing Model
- 3 Currency Hedging
- 3.1 The rate of hedged asset classes
- 3.2 Time horizon and mean reversion
- 3.3 Tradeoff between risk and return under consideration of hedging strategies
- 3.4 Black's Universal Hedging
- 3.5 Implications for currency hedging
- 4 Asset Allocation and Portfolio Choice
- 4.1 Forms of Asset Allocation
- 4.2 Risk, return and investment horizon
- 4.3 Principles and decision points in Strategic Asset Allocation
- 4.4 Inflation indexed bonds as an alternative investment
- 4.5 Strategic Asset Allocation under consideration of VaR principles
- 4.6 Mutual fund theorem and upcoming mean reverting
- 5 Conclusion
Zielsetzung und Themenschwerpunkte (Objectives and Key Themes)
This paper aims to examine the role of currency hedging within strategic asset allocation and the international capital asset pricing model (ICAPM). It explores the complexities of international investment, highlighting the weaknesses of the ICAPM and the importance of considering currency risk. The paper also investigates optimal hedging strategies and alternative investment options for risk-averse investors. * Strategic Asset Allocation and the ICAPM * Currency Hedging Strategies * International Diversification and Currency Risk * Risk and Return Trade-offs * Alternative Investments (Inflation-Indexed Bonds)Zusammenfassung der Kapitel (Chapter Summaries)
1 Introduction: This introductory chapter sets the stage by outlining the paper's objective: to analyze the significance of currency hedging within the framework of strategic asset allocation and the ICAPM. It establishes the central problem – the complexities of international investing due to currency fluctuations and inflation risk – and introduces the methodology used throughout the paper. The chapter emphasizes the limitations of traditional portfolio models that neglect these crucial factors, thus motivating the need for a more comprehensive approach incorporating currency hedging. 2 International Capital Asset Pricing Model: This chapter delves into the ICAPM, its assumptions, and its limitations in the context of international diversification. It discusses the challenges posed by different currencies and consumption preferences across countries, emphasizing that a simple extension of the domestic CAPM is insufficient. The discussion centers on Black's global equilibrium model, highlighting its assumptions and the determination of the optimal currency hedging percentage based on investor risk aversion. The chapter lays the groundwork for the subsequent exploration of currency hedging strategies by emphasizing the complexities introduced by currency risk in international portfolio management. 3 Currency Hedging: This chapter presents a quantitative analysis of currency hedging, exploring the optimal hedge ratio and the rationale behind avoiding a 100% hedge. It examines the relationship between the time horizon of an investment and the appropriate hedge ratio, highlighting Black's Universal Hedging Model which demonstrates the inefficiency of fully hedging a portfolio. The chapter likely integrates various hedging strategies and their implications for risk and return, providing practical guidance for portfolio managers seeking to mitigate currency risk while optimizing portfolio performance. 4 Asset Allocation and Portfolio Choice: This chapter explores various asset allocation strategies, differentiating between short-term tactical and long-term strategic approaches. It delves into the considerations of risk, return, and investment horizon in shaping asset allocation decisions. A key focus is on alternative investments, particularly inflation-indexed bonds (TIPS), as a risk-mitigation strategy for risk-averse investors. The chapter likely also covers Value-at-Risk (VaR) principles and the mutual fund theorem in the context of portfolio diversification and the implications of mean reversion on hedging strategies.Schlüsselwörter (Keywords)
Strategic Asset Allocation, International Capital Asset Pricing Model (ICAPM), Currency Hedging, Inflation Risk, Risk-Return Tradeoff, Portfolio Diversification, Black's Universal Hedging Model, Inflation-Indexed Bonds (TIPS), Value-at-Risk (VaR), Mean Reversion.
Frequently Asked Questions: A Comprehensive Language Preview
What is the main topic of this paper?
This paper examines the role of currency hedging within strategic asset allocation and the international capital asset pricing model (ICAPM). It explores the complexities of international investment, highlighting the weaknesses of the ICAPM and the importance of considering currency risk. The paper also investigates optimal hedging strategies and alternative investment options for risk-averse investors.
What are the key themes explored in the paper?
The key themes include strategic asset allocation and the ICAPM, currency hedging strategies, international diversification and currency risk, risk and return trade-offs, and alternative investments (like inflation-indexed bonds).
What is the structure of the paper?
The paper is structured into five chapters: An introduction outlining the objectives and methodology; a chapter on the International Capital Asset Pricing Model (ICAPM) and its limitations; a chapter dedicated to currency hedging strategies; a chapter on asset allocation and portfolio choice; and finally, a conclusion.
What are the key takeaways from the introduction?
The introduction sets the stage by highlighting the complexities of international investing due to currency fluctuations and inflation risk. It emphasizes the limitations of traditional portfolio models that neglect these factors and introduces the methodology used to address these limitations.
What does the chapter on the International Capital Asset Pricing Model (ICAPM) cover?
This chapter delves into the ICAPM, its assumptions, and limitations in the context of international diversification. It discusses challenges posed by different currencies and consumption preferences across countries, focusing on Black's global equilibrium model and its implications for optimal currency hedging.
What is discussed in the chapter on currency hedging?
This chapter quantitatively analyzes currency hedging, exploring optimal hedge ratios and the rationale behind avoiding a 100% hedge. It examines the relationship between investment time horizons and appropriate hedge ratios, highlighting Black's Universal Hedging Model and its implications for risk and return.
What topics are covered in the chapter on asset allocation and portfolio choice?
This chapter explores various asset allocation strategies (tactical and strategic), considering risk, return, and investment horizons. It focuses on alternative investments like inflation-indexed bonds (TIPS) as risk-mitigation strategies, Value-at-Risk (VaR) principles, and the mutual fund theorem in portfolio diversification, including the impact of mean reversion on hedging strategies.
What are the main conclusions of the paper?
(The specific conclusions are not detailed in the provided preview. The conclusion chapter would summarize the findings related to currency hedging within strategic asset allocation and the ICAPM).
What are the key words associated with this paper?
Strategic Asset Allocation, International Capital Asset Pricing Model (ICAPM), Currency Hedging, Inflation Risk, Risk-Return Tradeoff, Portfolio Diversification, Black's Universal Hedging Model, Inflation-Indexed Bonds (TIPS), Value-at-Risk (VaR), Mean Reversion.
Where can I find a more detailed version of this paper?
(The provided preview doesn't indicate where the full paper can be found.)
- Citation du texte
- Philipp Kowollik (Auteur), 2004, Strategic Asset Allocation and International CAPM, Munich, GRIN Verlag, https://www.grin.com/document/35314
