International Bond Portfolio Diversification

This paper addresses two related issues in international finance. First, existing theory and empirical evidence suggest that domestic agents should invest abroad and simultaneously hedge the implied exchange rate risk, a somewhat paradoxical proposition. Second, investors seem to exhibit "home bias" in that the proportion of foreign assets they hold is admittedly very low. We derive and compare optimal demands for three different strategies: one involving foreign bonds, one involving currency forwards and the last one involving currency futures.

LIOUI, A. and PONCET, P. (1999). International Bond Portfolio Diversification. ESSEC Business School.