Global Currency Hedging

Abstract

Over the period 1975 to 2005, the U.S. dollar (particularly in relation to the Canadian dollar), the euro, and the Swiss franc (particularly in the second half of the period) moved against world equity markets. Thus, these currencies should be attractive to risk-minimizing global equity investors despite their low average returns. The risk-minimizing currency strategy for a global bond investor is close to a full currency hedge, with a modest long position in the U.S. dollar. There is little evidence that risk-minimizing investors should adjust their currency positions in response to movements in interest differentials. Copyright (c) 2009 the American Finance Association.

International Diversification Benefits with Foreign Exchange Investment Styles*

“…Glen and Jorion (1993), as well as de Roon, Nijman, and Werker (2003), do not find (significant) diversification benefits of simple currency positions that go beyond fully hedging the currency risk exposure of stock and bond portfolios. Campbell, de Medeiros, and Viceira (2010) report higher Sharpe ratios for fully hedged and optimally hedged portfolios than for unhedged portfolios. Interestingly, all three studies find further increased Sharpe ratios for portfolios following a hedging strategy conditional on the interest rate differential of the domestic country to the foreign (hence, mimicking a kind of carry trade strategy).…”

“…Interestingly, all three studies find further increased Sharpe ratios for portfolios following a hedging strategy conditional on the interest rate differential of the domestic country to the foreign (hence, mimicking a kind of carry trade strategy). 8 This result leads Campbell, de Medeiros, and Viceira (2010) to conclude that, given "the high historical returns to the currency carry trade, foreign currencies are likely to play an important role in such a portfolio choice analysis." Our study is motivated by these initial findings in the extant literature on diversification on simple carry trade investing as well as the considerable returns to other FX investment styles documented elsewhere (e.g.…”

“…Notwithstanding, several studies carefully consider the exchange rate component in foreign investments, such as Glen andJorion (1993), de Roon, Nijman, andWerker (2003), and most recently Campbell, de Medeiros, and Viceira (2010). However, these studies consider the role of single currency positions and their role for international portfolios.…”

Risk Control in Asset Management: Motives and Concepts

“…Observed returns are then used to determine posterior probability weights for each of the models considered applying Bayes rule. 15 Each of the competing models generates a predictive density for the next period's return. After observing the return, models which have assigned a high likelihood to the observed value (compared to others) experience an upward revision of their probability weight.…”

“…This might be due to specialization of the investor in a certain asset class, making it desirable to hedge against risks not primarily driving the returns of this asset class. A popular example is currency risk, which has been recently analyzed by Campbell et al [15] who find full currency hedging to be optimal for a variance-minimizing bond investor, but discuss the potential for overall risk reduction from keeping foreign exchange exposure partly unhedged in the case of equity portfolios.…”