Hi All, I'm trying to construct a non-funded 'carry' based portfolio of G-10currencies (borrowing in low yielding and lending in high

yielding).I assume my home currency to be USD. I use a Markowitz constrained mean-variance optimisation. I've constructed a variance-covariance matrix from historical log returns -> ln(Exchange Rate[t+1]/Exchange Rate[t]). USD being home currency, while calculating variance of portfolio, I set the variance of USD and its covariance with other currencies as zero (effectively annulling USD weight/factor in variance calculation). Although I use USD LIBOR (along with other 9 rates) while maximizing expected return from the portfolio at any given risk. The results I get are not very intuitive as USD turns out to be 100% funded or funding currency. I tried modeling the same with USD as a risk free asset. I made an efficient frontier out of the rest 9 currencies with the net position in the portfolio of 9 currencies being zero. But still at the optimal point, I can have only 100% funded or funding exposure in USD. Am I right in my assumption of USD (Home Currency) variance being zero? Or how do I calculate the correlation of any currency with USD as returns in any currency are defined in terms of USD itself. How do I incorporate USD in my model? Thanks in anticipation! Regards, Ankur PRUTHI, IIMK 2005-07