Conditional Hedging and Portfolio Performance
Posted: 22 Mar 2003
Simple conditional currency-hedging rules often increase risk-adjusted portfolio returns and are thus of interest to investors. Several researchers have reported successful application of a "forward hedge rule" (FHR) in which one hedges whenever the foreign currency trades at a forward premium. An alternative strategy, a "real-interest-rate hedge rule" (RIR), is based on hedging when the domestic real interest rate exceeds the foreign rate. As an extension, we propose a combination of these rules a "real forward hedge rule" (RFHR). We evaluate the performance of the rules for various currency, stock, and bond portfolios from the developed countries. In tests of risk-adjusted returns for 1976-1997, the RFHR significantly outperformed standard benchmarks and often beat the FHR and the RIR. Moreover, results of a simple dominance test for rolling 5- and 10-year periods suggest that the RFHR consistently improves portfolio performance for a U.S. investor.
Keywords: Risk Measurement and Management, Portfolio risk, Portfolio Management, Portfolio construction, Rebalancing, Portfolio Management: Implementation
Suggested Citation: Suggested Citation