INTERNATIONAL DIVERSIFICATION AND OPTIMAL POSITION IN FOREIGN CURRENCY

Abstract

The paper deals with the problem of determining an optimal position in foreign currency for an international investor. The effectiveness of international diversification is considered in the first part of the paper. In the second part the author considers modern models designed for determining the optimal position in currency for international investor depending on his aims (risk minimization, financial wealth maximization). The author suggests ways to improve this model, aimed both to increase the quality of approximation of processes of changing prices in financial markets and to improve the accuracy of recording the investor’s preferences by including coherent or spectral risk measures in the financial wealth maximizing function. When standard dispersion is used to model investor’s preferences it is assumed that the value of the portfolio for investor depends equally on positive and negative returns. Actually, the investor reacts more to losses than to a large positive return. This fact is of great importance for investment funds managers seeking to minimize the outflow of funds during economic instability. To improve the quality of approximation of financial assets prices the author
suggests using dynamic conditional correlation matrix to model different assets return interdependence. As Russian stock market is quite risky (in comparison with capital markets in developed countries) it’s reasonable to use the processes with random jumps for modeling stock prices.