Currency Hedging: A Free Lunch?

Abstract:     
We address the question of whether currency hedging is a 'free lunch' of risk reduction and zero expected returns. Using a long history of hedged and unhedged MSCI indices, we find that hedging does not always reduce risk and mean returns are not zero. Contrary to prior studies, we find there is no free lunch for the equity investor. Instead, we conclude that the usual, intuitive relationships hold: less risk means lower returns, and more risk, higher returns. Our research indicates that the decision whether to hedge depends not only on the base currency, market, and hedging horizon, but also on the investor's goals.

Number of Pages in PDF File: 15

Keywords: Currency hedging, foreign exchange, currency risk management

JEL Classification: F31, G11, G15

working papers series