International Portfolio Diversification And The Foreign Exchange Risk Premium PDF Download

This dissertation examines the use of portfolio insurance strategies to manage foreign exchange risk faced by investors domiciled in the United States. The investors manage their foreign exchange exposure by purchasing foreign exchange traded options in the futures market, the spot market, or in both markets. Option investment has been analyzed in the domestic stock option literature as part of portfolio insurance strategies. These portfolio insurance strategies examine the impact on the payoff pattern of adding options to a well-diversified portfolio of stock. The addition of foreign exchange call options to a portfolio that contains only the domestic riskless asset adds limited foreign exchange risk. Alternatively, the addition of foreign exchange put options to a foreign exchange holding limits foreign exchange risk. The degree of foreign exchange risk added depends on the relative quantities and terms of the assets and the options in the portfolio. This dissertation examines several hypotheses about the value of three alternative portfolio insurance strategies implemented in the spot market and in the futures market. This research addresses the following research question: which portfolio insurance method is optimal for an investor? The question is examined by testing hypotheses using paired historical returns. The returns are calculated using traded fiduciary calls, traded protective puts, and dynamic replication of fiduciary calls in the spot market and in the futures market. The tests of the hypotheses indicate that the mean returns for strategies in the spot market are greater than mean returns for strategies in the futures market for premium fiduciary calls and discount protective puts, but that futures protective put mean returns are greater than spot protective put mean returns for discount currencies. The fiduciary call strategy has greater mean returns than the protective put strategy in the spot market for premium currencies but the spot protective put strategy has greater mean returns for the discount currency ...