Optimal currency hedge and the carry trade

Filipozzi, Fabio; Harkmann, Kersti

doi:10.1108/raf-10-2018-0219

Cited by 4 publications

(2 citation statements)

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“…dynamic hedging benchmarks. On a similar note, Filipozzi and Harkmann (2020) show that carry trades are a part of an optimal portfolio. The well-known stylized fact of the heavy-tailed distribution of the equity returns is also present in currency returns as well as in the fully hedged portfolio returns comprised of equities and bonds.…”

Section: Introductionmentioning

confidence: 89%

Dynamic currency hedging with non-Gaussianity and ambiguity

Polak,

Ulrych

2024

Quantitative Finance

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This paper introduces a non-Gaussian dynamic currency hedging strategy for globally diversified investors with ambiguity. It provides theoretical and empirical evidence that, under the stylized fact of non-Gaussianity of financial returns and for a given optimal portfolio, the investor-specific ambiguity can be estimated from historical asset returns without the need of additional exogenous information.Acknowledging non-Gaussianity, we compute an optimal ambiguity-adjusted mean-variance (dynamic) currency allocation. Next, we propose an extended filtered historical simulation that combines Monte Carlo simulation based on volatility clustering patterns with the semi-parametric non-normal return distribution from historical data. This simulation allows us to incorporate investor's ambiguity into a dynamic currency hedging strategy algorithm that can numerically optimize an arbitrary risk measure, such as the expected shortfall. The out-of-sample backtest demonstrates that, for globally diversified investors, the derived non-Gaussian dynamic currency hedging strategy is stable, robust, and highly risk reductive. It outperforms the benchmarks of constant hedging as well as static/dynamic hedging approaches with Gaussianity in terms of lower maximum drawdown and higher Sharpe and Sortino ratios in gross terms and net of transaction costs.

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Section: Introductionmentioning

confidence: 89%

Dynamic currency hedging with non-Gaussianity and ambiguity

Polak,

Ulrych

2024

Quantitative Finance

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“…The results of the study indicate significant and persistent cross-country differences in risk aversion in the interest-rate market compared to the implied risk aversion in the stock market. Filipozzi and Harkmann (2020) investigate the efficiency of different hedging strategies for an investor holding a portfolio of foreign currency bonds by comparing the strategies of no hedge with those of fully hedged. The authors make use of the ordinary least squares (OLS) approach and the optimal hedge ratios to this end.…”

Section: Introductionmentioning

confidence: 99%

The Relationship between Carry Trade and Asset Markets in South Africa

Bonga‐Bonga

Maake

2021

JRFM

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This paper investigates the extent of volatility or risk spillovers between the currency carry trade and asset markets, namely the equity and bond markets, in South Africa to infer the extent of the connectivity between the two markets. The carry trade operation examined in this paper involves two strategies, both of which use the South African rand as the investment currency, with the U.S. dollar and the Japanese yen as the funding currencies. The vector autoregressive BEKK-Generalised Autoregressive Conditional Heteroscedastic (multivariate VAR-BEKK-GARCH) model is used to this end. Moreover, the paper assesses the dynamic correlation between each currency carry trade and asset markets to infer the time-varying dependence between the two markets. The results of the empirical analysis show evidence of volatility spillover between the carry trade returns and the two asset market returns. The extent of the spillover depends on the choice of the funding currency, with the U.S. dollar-funded strategy transmitting more shocks to the South African equity market compared to the bond market. Moreover, the synchronisation of the dynamic correlation between each asset market and the currency carry trade returns shows that any possibility of arbitrage is precluded in the currency carry trade market.

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Measuring minimum variance hedging effectiveness: Traditional vs. sophisticated models

Sharma

Karmakar

2023

International Review of Financial Analysis

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Optimal currency hedge and the carry trade

Cited by 4 publications

References 30 publications

Dynamic currency hedging with non-Gaussianity and ambiguity

Dynamic currency hedging with non-Gaussianity and ambiguity

The Relationship between Carry Trade and Asset Markets in South Africa

Measuring minimum variance hedging effectiveness: Traditional vs. sophisticated models

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