An Integrated Approach to Currency Factor Timing

Using the G10 universe of currencies, we find evidence in favor of parametric portfolio policies to guide an optimal currency tilting strategy using cross-sectional factor characteristics, but less so an optimal currency timing strategy using time series predictors. While currency carry serves as the main return generator, the two characteristics momentum and value are implicit diversifiers to potentially balance the downside of the FX carry investing in flight-to-quality shifts of FX investors. In particular, we seek to expand the parametric portfolio policy’s ability to mitigate the downside of the carry trade by incorporating an explicit currency factor timing element. Our proposed integrated approach not only outperforms a naive equally weighted benchmark, but also univariate and multivariate parametric portfolio policies. JEL classification: G11, D81, D85