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.
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
Research Objectives and Key Topics
The primary objective of this paper is to examine the role of currency hedging within the framework of Strategic Asset Allocation and the International Capital Asset Pricing Model. It addresses the research question of how investors can optimize portfolio performance by balancing risk, return, and currency exposure in an international context.
- Theoretical foundations of the International Capital Asset Pricing Model (ICAPM).
- Quantitative and strategic approaches to currency hedging.
- Methods of asset allocation including Strategic, Tactical, and Insured Asset Allocation.
- The impact of investment horizon, mean reversion, and inflation-indexed bonds on portfolio choice.
Excerpt from the Book
1.1 Goal of the paper and problem setting
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. 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.
Summary of Chapters
1 Introduction: This chapter outlines the goals and methodology of the research, emphasizing the importance of Strategic Asset Allocation and the necessity of currency hedging.
2 International Capital Asset Pricing Model: This section discusses the theoretical framework of the international CAPM, its assumptions, and the challenges introduced by international diversification.
3 Currency Hedging: This chapter explores various hedging strategies, the optimal hedge ratio, and the concept of mean reversion in exchange rates.
4 Asset Allocation and Portfolio Choice: This section details different forms of asset allocation and investment strategies, including the use of inflation-indexed bonds and VaR principles.
5 Conclusion: The final chapter synthesizes the findings, confirming that currency hedging is essential for managing internationally diversified portfolios.
Keywords
Strategic Asset Allocation, Currency Hedging, ICAPM, Portfolio Management, Risk-Return Tradeoff, Mean Reversion, Inflation-Indexed Bonds, Value-at-Risk, International Diversification, Asset Allocation, Hedge Ratio, Investment Horizon, Mutual Fund Theorem, Financial Markets, Risk Aversion
Frequently Asked Questions
What is the primary focus of this research paper?
The paper focuses on the integration of currency hedging within Strategic Asset Allocation, specifically applying the International Capital Asset Pricing Model to optimize international portfolios.
What are the core thematic fields covered?
The work covers portfolio theory, currency risk management, the ICAPM, different asset allocation methodologies, and the impact of inflation on investment decisions.
What is the main objective or research question?
The study aims to determine how international investors can mitigate currency risks while seeking to maximize returns within a structured asset allocation framework.
Which scientific methods are employed?
The author uses a theoretical and analytical review of financial models (such as CAPM and ICAPM), historical data insights, and quantitative reasoning regarding hedging ratios and asset allocation strategies.
What topics are discussed in the main body?
The main body examines models for international asset pricing, the necessity of currency hedging, the dynamics of time horizons, mean reversion, and the use of alternative investments like TIPS.
Which keywords characterize the work?
The work is characterized by terms such as Strategic Asset Allocation, Currency Hedging, ICAPM, Mean Reversion, and Portfolio Performance.
Why is a 100% currency hedge often considered inefficient?
Based on Black’s Universal Hedging Model, the paper explains that a 100% hedge is often inefficient because it ignores the complexities of correlations between asset returns and currency movements.
How do TIPS function as an alternative investment?
TIPS (Treasury inflation-indexed bonds) serve as a safe investment opportunity for risk-averse investors because they account for country-specific inflation rates, effectively removing inflation risk from the investment return.
- Citation du texte
- Philipp Kowollik (Auteur), 2004, Strategic Asset Allocation and International CAPM, Munich, GRIN Verlag, https://www.grin.com/document/35314
