Currency hedging of global portfolios - a closer examination of some of the ingredients
AbstractThe paper analyzes some of the ingredients of currency hedging and portfolio construction against the framework of mean-variance efficient portfolios. The currency hedging analysis is based on a range of exchange rates, consisting of the domestic dollar vis-à-vis the US dollar, the euro, the yen, the pound and Hong Kong dollar mainly from an Australian perspective. Our analysis focuses on the following input factors into the hedging process of foreign assets/liabilities. We explore the implications of the secular downward trend of the real trade-weighted exchange rate index of the domestic dollar for hedging effectiveness. The hedging costs resulting from unexpected cash flows and portfolio adjustments are in part estimated through a simulated forward contract hedging technique. The relevant inputs into the variance-covariance matrix of the optimal portfolio selection process are estimated on the basis of historical data. Comparing the forecast errors of share index and currency volatilities, using historical, implied and GARCH methods, provides mixed results. The paper also investigates a select number of forecasting methods that may be applied to other hedging inputs.
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Bibliographic InfoPaper provided by Macquarie University, Department of Economics in its series Research Papers with number 0411.
Length: 51 pages.
Date of creation: Oct 2004
Date of revision:
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-05-20 (All new papers)
- NEP-FIN-2006-05-20 (Finance)
- NEP-FMK-2006-05-20 (Financial Markets)
- NEP-FOR-2006-05-20 (Forecasting)
- NEP-IFN-2006-05-20 (International Finance)
- NEP-RMG-2006-05-20 (Risk Management)
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