An International Equity and Currency Optimisation with Frictions

Abstract

This study proposes a novel joint optimization approach for international portfolios, optimizing the allocation of stocks and exposure to currencies. We employ several equity characteristics including momentum, value, and size for equity allocation and carry trade, currency momentum, and currency value characteristics for currency allocation. Our out-of-sample analysis finds a 55% increase in the portfolios' Sharpe ratio, after transaction and rebalancing costs, compared to the benchmark, with no significant impact on overall volatility. This research highlights the importance of jointly optimizing both equity and currency strategies in portfolio construction, offering insights to international investors aiming to improve their risk-adjusted returns.

Keywords: asset allocation, currency overlay, portfolio choice, portfolio optimization

JEL Classification: F31; F37; G11; G12; G15.