Empirical Analysis of Global Bond Investments Based on Fundamentals

International investments grows steadily. However, the benefits of diversification across markets are more often addressed for stock than for bond portfolios. In the later case, currency volatility cannot be ruled out because interest rate and exchange rate levels of risk are similar. Most studies related to this interesting subject specially in continental Europe give arguments for international diversification based on ex-post efficient frontiers and address the issue of hedging the exchange rate risk. This paper shows how two simple ideas could have helped investors to gain from international diversification ex-ante. It is assumed that real rates in every market tend to revert to a five year average and that exchange rates revert to the moving average of purchasing power parity. Portfolio composition of investors based in various currencies are optimized in a mean-variance framework. Empirical study over the last business cycle tend to demonstrate that significant out performance could have been achieved, with very little increment of risk. Surprisingly, investors based in strong currencies had a big incentive to invest in bond markets denominated in weaker currencies, despite the currency depreciation.