Dynamic Global Currency Hedging

62 Pages Posted: 19 Jan 2016 Last revised: 16 Nov 2018

See all articles by Bent Jesper Christensen

Bent Jesper Christensen

Aarhus University; Aarhus University; Aarhus University

Rasmus Tangsgaard Varneskov

Copenhagen Business School - Department of Finance; Nordea Bank AB - Nordea Asset Management

Date Written: November 16, 2018

Abstract

This paper proposes a model for discrete-time hedging based on continuous-time movements in portfolio and foreign currency exchange rate returns. In particular, the vector of optimal currency exposures is shown to be given by the negative realized regression coefficients from a one-period conditional expectation of the intra-period quadratic covariation matrix for portfolio and foreign exchange rate returns. These are labelled the realized currency betas. The model, hence, facilitates dynamic hedging strategies that depend exclusively on the dynamic evolution of the ex-post quadratic covariation matrix. These hedging strategies are suggested implemented using modern, yet simple, non-parametric techniques to accurately measure and dynamically model historical quadratic covariation matrices. The empirical results from an extensive hedging exercise for equity investments illustrate that the realized currency betas exhibit important time variation, leading to substantial economic, as well as statistically significant, volatility reductions from the proposed hedging strategies, compared to existing benchmarks, without sacrificing returns. As a result, a risk-averse investor is shown to be willing to pay several hundred basis points to switch from existing hedging methods to the proposed realized currency beta approach. Interestingly, the empirical analysis strongly suggests that the superior performance of the latter during the most recent global financial crisis of 2008 is, at least partially, funded by carry traders.

Keywords: Currency Hedging, Foreign Exchange Rates, High-frequency Data, Infill Asymptotics, Mean-Variance Analyis, Quadratic Covariation, Realized Currency Beta

JEL Classification: C14, C32, C58, G11, G15

Suggested Citation

Christensen, Bent Jesper and Varneskov, Rasmus Tangsgaard, Dynamic Global Currency Hedging (November 16, 2018). Available at SSRN: https://ssrn.com/abstract=2717808 or http://dx.doi.org/10.2139/ssrn.2717808

Bent Jesper Christensen

Aarhus University ( email )

Fuglesangs Alle 4
DK-8210 Aarhus V, 8210
Denmark

Aarhus University ( email )

Fuglesangs Alle 4
DK-8210 Aarhus V, 8210
Denmark

Aarhus University ( email )

Fuglesangs Alle 4
DK-8210 Aarhus V, 8210
Denmark

Rasmus Tangsgaard Varneskov (Contact Author)

Copenhagen Business School - Department of Finance ( email )

A4.17 Solbjerg Plads 3
Copenhagen, Frederiksberg 2000
Denmark

Nordea Bank AB - Nordea Asset Management ( email )

PO Box 850
Copenhagen, 0900
Denmark

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