Optimize International Portfolio via Stochastic Programming

We propose a two-stage stochastic programming method for dynamic international portfolio management in a holistic view aiming at attaining an effective balance between portfolio´s currency risk exposure and its realized expected return. By modeling the uncertainty with a scenario tree that reflects the historical distribution as well as related information, and elaborating an integrated optimization framework for asset allocation and currency risk hedging, state-contingent rebalancing decisions including capital allocation, asset selection, and appropriate currency hedging levels can be considered dynamically and automatically. According to extensive empirical analysis, our approach not only provides an effective decision tool for international asset allocation but also pay attention to incremental advantages arising from the jointly realization of currency forward contracts. We also illustrate potential benefits stemming from unrestricted application of currency forward contracts for speculative trading.