Safety First Diversification and Currency Hedging in International Portfolios

WP 95-32

Posted: 1 Jul 1998

See all articles by Dennis W. Jansen

Dennis W. Jansen

Texas A&M University - Department of Economics

Kees C. G. Koedijk

Tilburg University - Department of Finance

Date Written: Undated

Abstract

The paper looks at currency hedging and international diversification of equity portfolios from a safety first perspective. We modify Arzac and Bawa's (1977) version of the Roy's safety first criterion and show how it can be successfully improved upon by exploiting the fat tail property of asset returns and the statistical theory of extremes. The latter provides a much sharper bound on the probability of disastrous returns than does the Chebyshev bound. We look at currency hedging for a portfolio of international currencies without regard for the underlying investment, and find relatively high levels of hedging. Then we look at currency hedging for a given international equity portfolio and find lower hedge ratios, showing a portfolio effect of international diversification in reducing risk of currency movements. Finally, we look at joint optimization of portfolio composition and hedging, and find further evidence of portfolio effects between equity returns in local currency and exchange rate movements.

JEL Classification: G11, G15

Suggested Citation

Jansen, Dennis W. and Koedijk, Kees G., Safety First Diversification and Currency Hedging in International Portfolios (Undated). WP 95-32, Available at SSRN: https://ssrn.com/abstract=7375

Dennis W. Jansen

Texas A&M University - Department of Economics ( email )

5201 University Blvd.
College Station, TX 77843-4228
United States
409-845-7358 (Phone)
409-847-8757 (Fax)

Kees G. Koedijk (Contact Author)

Tilburg University - Department of Finance ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 4663048 (Phone)
+31 13 4662052 (Fax)

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Abstract Views
2,345
PlumX Metrics