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Beyond the Carry Trade: Optimal Currency Portfolios

2015; Cambridge University Press; Volume: 50; Issue: 5 Linguagem: Inglês

10.1017/s0022109015000460

1756-6916

Pedro Barroso, Pedro Santa‐Clara,

Monetary Policy and Economic Impact

Abstract We test the relevance of technical and fundamental variables in forming currency portfolios. Carry, momentum, and value reversal all contribute to portfolio performance, whereas the real exchange rate and the current account do not. The resulting optimal portfolio produces out-of-sample returns that are not explained by risk and are valuable to diversified investors holding stocks and bonds. Exposure to currencies increases the Sharpe ratio of diversified portfolios by 0.5 on average, while reducing crash risk. We argue that besides risk, currency returns reflect the scarcity of speculative capital.