Do Asset-demand Functions Optimize over the Mean and Variance of Real Returns? a Six-currency Test

International asset demands are functions of expected returns. Optimal portfolio theory tells us that the coetlicients in this relationship depend on the variance-covariance matrix of real returns. But previous estimates of the optimal portfolio (1) assume expected returns constant and (2) are not set up to test the hypothesis of mean-variance optimization. We use maximum likelihood estimation to impose a constraint between the coetlicients and the error variancecovariance matrix. For a portfolio of six currencies, we are able statistically to reject the constraint. Evidently investors are either not sophisticated enough to maximize a function of the mean and variance of end-of-period wealth, or else are too sophisticated to do so.