An individual’s optimal portfolio strategy, in an international economy where PPP is violated and there are K state variables, is shown to contain in addition to the usual speculative component, only two hedging components, however large is K. The first one is associated with domestic interest rate risk and the second one with the risk brought about by the co-movements of interest rates and the market prices of risk. Our decomposition leads to an easier implementation of the strategy and to optimal (indirect) currency risk hedging.
LIOUI, A. et PONCET, P. (2003). International Asset Allocation: A New Perspective. Journal of Banking and Finance, pp. 2203-2230.