CURRENCY RISK AND ASIA-PACIFIC OFFICE PORTFOLIO DIVERSIFICATION

Abstract

Benefits of portfolio risk reduction and enhanced returns from international diversification of real estate investments has led to increasing interest amongst institutional investors to search for investment opportunities in the world including Asia. However, the exchange rate volatility may erode these benefits. This study aims to examine the impact of the recent regional economic and currency crisis of 1997 on real estate portfolio diversification. After analyzing real estate data from eight Asia Pacific countries, namely Hong Kong, Japan, Singapore, Thailand, Indonesia, Malaysia, Australia and New Zealand, the impact of currency risk on these Asia-Pacific office investment is generally statistically insignificant especially over a long investment period except for Indonesia, which experienced highest negative exchange rate returns due to high currency fluctuations especially during the short-term crisis. However, diversification benefits can still be reaped in shorter holding penod, especially in the last ! 14-year sub-period (1997Q3-1998Q4), where greater maximization of individual expected risk-adjusted portfolio returns and portfolio risk minimization within the efficient frontier is possible even in times of crisis. In conclusion, the impact of currency risk is statistically insignificant to make international diversification ineffective in reaping portfolio diversification benefits, especially when the investment period is long enough. Efficient asset selection and portfolio allocation is more crucial in maximizing expected portfolio returns. Thus, portfolio managers and institutional investors should consider the correlation of investment returns and the economic and political factors of the various countries other than currency risk itself for long-term portfolio diversification.