Volatility and Correlation Timing in Active Currency Management

This chapter examines how dynamic volatilities and correlations in exchange rate returns affect the optimal portfolio choice of a risk-averse investor engaging in international asset allocation. We take a Bayesian approach in estimation and asset allocation that accounts for parameter and model uncertainty, and find substantial economic value in both volatility and correlation timing. This result is robust to reasonable transaction costs, parameter and model uncertainty, and alternative specifications for volatilities and correlations