15. Volatility and Correlation Timing in Active Currency Management

  1. Jessica James,
  2. Ian W. Marsh3 and
  3. Lucio Sarno3,4
  1. Pasquale Della Corte1,
  2. Lucio Sarno3,4 and
  3. Ilias Tsiakas2

Published Online: 8 OCT 2012

DOI: 10.1002/9781118445785.ch15

Handbook of Exchange Rates

Handbook of Exchange Rates

How to Cite

Della Corte, P., Sarno, L. and Tsiakas, I. (2012) Volatility and Correlation Timing in Active Currency Management, in Handbook of Exchange Rates (eds J. James, I. W. Marsh and L. Sarno), John Wiley & Sons, Inc., Hoboken, NJ, USA. doi: 10.1002/9781118445785.ch15

Editor Information

  1. 3

    Cass Business School, London, UK

  2. 4

    CEPR, UK

Author Information

  1. 1

    Imperial College, London, UK

  2. 2

    Department of Economics and Finance, University of Guelph, Guelph, Ontario, Canada

  3. 3

    Cass Business School, London, UK

  4. 4

    CEPR, UK

Publication History

  1. Published Online: 8 OCT 2012
  2. Published Print: 14 JUN 2012

ISBN Information

Print ISBN: 9780470768839

Online ISBN: 9781118445785

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Keywords:

  • active currency management;
  • Bayesian asset allocation;
  • constant relative risk aversion (CRRA);
  • correlation timing;
  • model uncertainty;
  • parameter uncertainty;
  • volatility timing

Summary

The expected volatilities and correlations of asset returns are a critical input in the optimal portfolio choice of a risk-averse investor. This chapter addresses an essential question that lies at the core of a long line of research in empirical finance: does volatility and correlation timing matter for the optimal asset allocation of a risk-averse investor and, if so, how? It lays out the multivariate conditional volatility and correlation models, and briefly explains the Bayesian estimation methods. The chapter discusses the framework for assessing the economic value of volatility and correlation timing for a risk-averse investor with a constant relative risk aversion (CRRA) portfolio allocation strategy. The effect of parameter uncertainty on asset allocation is also discussed, while model uncertainty and the construction of combined forecasts are described. Finally, the empirical results are reported.

Controlled Vocabulary Terms

active currency management; Bayesian asset allocation; constant relative risk aversion (CRRA); correlation timing; model uncertainty; parameter uncertainty; volatility