Exploring stock price portfolio clusters in foreign exchange markets

Abstract

This study explores a novel portfolio management approach dividing the currency pairs into clusters of periodic returns. The primary purpose is to improve diversification and risk-return ratios with currencies. This research studied USD, Euro, and Chinese Yuan to collect historical data from April 2012 to March 2022. The present study makes use of K-means clustering to find clusters of assets with similar return patterns, which constitute diversified portfolios. Optimized portfolio vs. benchmark portfolio performance was also evaluated based on critical performance measures like cumulative return, Sharpe ratio, and volatility. The clustering approach was also tested through sensitivity analysis to check how market-specific it is. The results suggest that more clustered portfolios outperform traditional benchmarks and provide a better risk-adjusted return. The conclusion drawn here from the findings is that portfolio segmentation is a superior approach because of risk management in ever-changing volatile markets and identifying situations that link currency pairs. This is beneficial for those investors and portfolio managers looking to maximize their foreign exchange (FOREX) investments by allowing greater visibility into how the market is functioning, which can, in turn, improve decision-making processes. According to the study, portfolio clustering substantially enhances a portfolio's return for the foreign exchange market.