Global Currency Hedging with Common Risk Factors
44 Pages Posted: 2 Nov 2018 Last revised: 16 Nov 2018
Date Written: November 15, 2018
We propose a novel method for dynamically hedging foreign exchange exposure in international equity and bond portfolios. The method exploits time-series predictability in currency returns that we find emerges from a forecastable component in currency factor returns. The hedging strategy outperforms leading alternative approaches out-of-sample across a large set of performance metrics. Moreover, we find that exploiting the predictability of currency returns via an independent currency portfolio delivers a high risk-adjusted return and provides superior diversification gains to global equity and bond investors relative to currency carry, value, and momentum investment strategies.
Keywords: global currency hedging, currency risk factors, currency returns, international portfolio diversification
JEL Classification: F31, G11, G15
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