Currency portfolios exhibit asymmetric correlations: during periods of bear, volatile world equity markets, currency portfolios provide different hedging benefits than in bull markets. I show how these time-varying hedging benefits depend on currency characteristics. This paper also illustrates how the presence of regime shifts in financial markets affects optimal portfolio choice across currency portfolios: during bear markets, investors are better off by unwinding carry trade positions, and by following currency momentum. Also, diversification benefits increase by holding undervalued currencies and currencies of countries with strong current accounts and international investment positions.

Keywords: Foreign Exchange, Safe Haven Currencies, Portfolio Choice, Uncovered Interest Rate Parity, Carry Trade, Purchasing Power Parity, Markov-switching

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