Foreign Currency for Long-Term Investors

41 Pages Posted: 5 Aug 2002

See all articles by John Y. Campbell

John Y. Campbell

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Luis M. Viceira

Harvard Business School - Finance Unit; National Bureau of Economic Research (NBER)

Joshua S. White

University of Illinois at Urbana-Champaign - Department of Finance

Multiple version iconThere are 3 versions of this paper

Date Written: June 2002

Abstract

Conventional wisdom holds that conservative investors should avoid exposure to foreign currency risk. Even if they hold foreign equities, they should hedge the currency exposure of these positions and should hold only domestic Treasury bills. This paper argues that the conventional wisdom may be wrong for long-term investors. Domestic bills are risky for long-term investors because real interest rates vary over time, and bills must be rolled over at uncertain future interest rates. This risk can be hedged by holding foreign currency if the domestic currency tends to depreciate when the domestic real interest rate falls, as implied by the theory of uncovered interest parity. Empirically, this effect is important and can lead conservative long-term investors to hold more than half their wealth in foreign currency.

Keywords: Foreign Exchange Rates, Home Bias, Intertemporal Hedging Demand, Portfolio Choice, Uncovered Interest Parity

JEL Classification: G12

Suggested Citation

Campbell, John Y. and Viceira, Luis M. and White, Joshua S., Foreign Currency for Long-Term Investors (June 2002). Harvard Business School Negotiation, Organizations and Markets Unit, Research Paper Series, Forthcoming; HBS Finance Working Paper No. 03-56. Available at SSRN: https://ssrn.com/abstract=320920 or http://dx.doi.org/10.2139/ssrn.320920

John Y. Campbell

Harvard University - Department of Economics ( email )

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HOME PAGE: http://scholar.harvard.edu/campbell

National Bureau of Economic Research (NBER)

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Luis M. Viceira (Contact Author)

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-495-6331 (Phone)
617-496-6592 (Fax)

HOME PAGE: http://www.people.hbs.edu/lviceira

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Joshua S. White

University of Illinois at Urbana-Champaign - Department of Finance ( email )

1206 South Sixth Street
Champaign, IL 61820
United States
(217) 244-1166 (Phone)

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