I propose a simple and robust approach to hedge currency risk that can be directly applied by international investors in diverse asset classes. Compared to current mean-variance approaches, it is robust to overfitting and thus better anticipates risk-minimizing currency positions for global equity, bond, and commodity investors out of sample. Furthermore, correlations among currencies, equities, and commodities can be predicted by lagged implied foreign exchange volatility. This allows investors to dynamically adjust their hedges, resulting in significantly lower risk compared to other hedging alternatives while maintaining or even improving Sharpe ratio, particularly during crisis periods. K E Y W O R D S dynamic currency hedging, implied volatility, mean-variance analysis, overfitting 1 INTRODUCTION Since the demise of the postwar Bretton Woods system in the 1970s, currency fluctuations have been a major financial risk. International securities can provide better risk-reward trade-offs, but in a regime of floating foreign exchange (FX) rates, any investor dealing with a foreign currency is inherently exposed to adverse FX movements. It is therefore natural to ask whether and how one can optimally hedge this currency risk. I propose a simple and robust mean-variance approach to hedge FX risk for investors globally-dynamic conditional currency hedging (DCCH). This entails three contributions. First, I document that current mean-variance hedging approaches break down out of sample due to their in-sample bias and tendency to overfit. Second, I propose DCCH as an alternate hedging mechanism that is less prone to overfit and performs favorably both in and out of sample. Compared to the alternatives discussed in the literature to date, this approach leads to lower standard deviation and downside risk while maintaining or improving Sharpe ratio. Third, correlation patterns between major currency pairs and other assets, such as equities and commodities, can be strongly predicted by implied FX volatility (IVOL). Using this as conditional information for DCCH further reduces risk and improves the risk-return relationship of hedged returns. This paper contributes to three related streams of literature on international diversification, global risk factors, and systematic FX investment styles. The benefits of international diversification have long been established in the 1960s

Are stocks' varying sensitivities to changing investor attention and sentiment priced? Employing internet search-based proxies for both, I find novel results that are consistent with theory. Stocks that co-vary negatively with increased investor attention to the stock market outperform in the following months in a behavior consistent with a risk premium. The pricing of co-variation with investor sentiment depends on aggregate mispricing (Baker-Wurgler index), behaving like a risk premium when mispricing is low and like an anomaly when mispricing is high. Sensitivity to both sentiment and attention is strongly related to idiosyncratic volatility and limits to arbitrage: High absolute attention/sentiment loadings are associated with higher volatility, smaller size and other limits to arbitrage. However, the priced attention and sentiment components are clearly distinct from the idiosyncratic risk puzzle and stay significant when controlling for relevant pricing factors and company characteristics. Investor attention is both very robust and highly powerful in pricing a broad variety of test assets. On the other hand, investor sentiment's effect on performance is strongly related to return reversal/momentum and does not add much information on its own.

No abstract