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Dynamic Global Currency Hedging
[Arbitrage in the Foreign Exchange Market: Turning on the Microscope]

Author

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  • Bent Jesper Christensen
  • Rasmus Tangsgaard Varneskov

Abstract

This article proposes a model for discrete-time currency hedging based on continuous-time movements in portfolio and foreign exchange rate returns. The vector of optimal currency exposures is given by the negative realized regression coefficients from a one-period conditional expectation of the intraperiod quadratic covariation matrix for portfolio and exchange rate returns. Empirical results from an extensive hedging exercise for equity investments illustrate that currency exposures exhibit important time variation, leading to substantial volatility reductions when hedging, without sacrificing returns. A risk-averse investor is willing to pay several hundred annual basis points to switch from existing hedging methods to the proposed dynamic strategies.

Suggested Citation

  • Bent Jesper Christensen & Rasmus Tangsgaard Varneskov, 2021. "Dynamic Global Currency Hedging [Arbitrage in the Foreign Exchange Market: Turning on the Microscope]," Journal of Financial Econometrics, Oxford University Press, vol. 19(1), pages 97-127.
    • Handle: RePEc:oup:jfinec:v:19:y:2021:i:1:p:97-127.
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    File URL: http://hdl.handle.net/10.1093/jjfinec/nbaa030
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    Cited by:

    1. Chen, Shu-Hsiu, 2017. "Carry trade strategies based on option-implied information: Evidence from a cross-section of funding currencies," Journal of International Money and Finance, Elsevier, vol. 78(C), pages 1-20.
    2. Melk C. Bucher, 2020. "Conditional currency hedging," Financial Management, Financial Management Association International, vol. 49(4), pages 897-923, December.
    3. Cho, Jae-Beom & Min, Hong-Ghi & McDonald, Judith Ann, 2020. "Volatility and dynamic currency hedging," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 64(C).

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    More about this item

    Keywords

    C; urrency hedging; foreign exchange rates; high-frequency data; quadratic covariation; realized currency beta;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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