The Introduction of Emerging Currencies into a Portfolio: Towards a more Complete Diversification Model

We have drawn on portfolio theory and international diversification in order to analyse strategies that help reduce emerging economy exposure to exchange-rate risk. We show that it may be efficient for an investor, by taking into account the several components of the global risk, to build up a portfolio of emerging-country assets denominated in local currency - unhedged against currency risk - compared with a strategy that includes emergingcountry securities denominated in foreign currencies. This strategy would lead to a reduction in the “original sin” (i. e. the inability of emerging economies to borrow in local currency), and de facto to a reduction in currency mismatches in balance sheets of emerging economies.International portfolio diversification; original sin; emerging countries; downside risk