Currency Overlay Techniques and Perspectives Essay

Currency Overlay Techniques and Perspectives - Essay Example What are the advantages and disadvantages, or more specifically, the risks and rewards, of several common currency overlay schemes? In â€Å"Mean/Variance Analysis of Currency Overlays† by Philippe Jorion, three of the four most common strategies are discussed and analyzed. These are 1) joint, or unit, currency management, its goal to optimize or hedge the entirety of the underlying assets, be they stocks, bonds, or currencies themselves; 2) partial optimization over the currencies, given a pre-determined position in the core portfolio; and 3) a separate optimization over currencies. In unit or joint hedging, it is assumed that â€Å"the manager has expertise in many asset classes and can structure a portfolio to account for correlations between assets and currencies,† (Jorion, 1994). Partial optimization manages currencies â€Å"separately from the core portfolio, but the manager still controls total portfolio risk.† Employing the method of separate optimization means to manage the currencies â€Å"completely independently of the rest of the portfolio,† even going so far as to measure their performance against a separate benchmark or hire a separate currency overlay manager to deal with this part of the portfolio as opposed to the equity manager. In the unit hedging approach, the tools work together to maximize the performance in light of the unique composition of the portfolio. Clearly, if done properly, this is the optimal approach.