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Foreign Currency for Long-Term Investors

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  • John Y. Campbell
  • Luis M. Viceira
  • Joshua S. White

Abstract

Conventional wisdom holds that conservative investors should avoid exposure to foreign currency risk. Even if they hold foreign equities, they should hedge the currency exposure of these positions and should hold only domestic Treasury bills. This paper argues that the conventional wisdom may be wrong for long-term investors. Domestic bills are risky for long-term investors, because real interest rates vary over time and bills must be rolled over at uncertain future interest rates. This risk can be hedged by holding foreign currency if the domestic currency tends to depreciate when the domestic real interest rate falls, as implied by the theory of uncovered interest parity. Empirically this effect is important and can lead conservative long-term investors to hold more than half their wealth in foreign currency.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9075.

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Date of creation: Jul 2002
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Publication status: published as Campbell, John Y., Luis M. Viceira and Joshua S. White. "Foreign Currency For Long-Term Investors," Economic Journal, 2003, v113(486,Mar), C1-C25.
Handle: RePEc:nbr:nberwo:9075

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Citations

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Cited by:
  1. Susan Thorp, 2004. "That Courage is not inconsistent with Caution: Foreign Currency Hedging for Superannuation Funds," Econometric Society 2004 Australasian Meetings 148, Econometric Society.
  2. Morse, Adair & Shive, Sophie, 2011. "Patriotism in your portfolio," Journal of Financial Markets, Elsevier, Elsevier, vol. 14(2), pages 411-440, May.
  3. Viceira, Luis & Serfaty-de Medeiros, Karine & Campbell, John, 2009. "Global Currency Hedging," Scholarly Articles 3153308, Harvard University Department of Economics.
  4. Philip R. Lane, 2006. "Global Bond Portfolios and EMU," The Institute for International Integration Studies Discussion Paper Series iiisdp168, IIIS.
  5. Brière, Marie & Signori, Ombretta, 2013. "Hedging inflation risk in a developing economy: The case of Brazil," Research in International Business and Finance, Elsevier, Elsevier, vol. 27(1), pages 209-222.
  6. Giorgio Valente & Lucio Sarno & Abhay Abhayankar, 2004. "Exchange Rates and Fundamentals: Evidence on the Economic Value of Predictability," Working Papers, Warwick Business School, Finance Group wp04-01, Warwick Business School, Finance Group.
  7. Walker, Eduardo, 2008. "Strategic currency hedging and global portfolio investments upside down," Journal of Business Research, Elsevier, vol. 61(6), pages 657-668, June.
  8. Suh, Sangwon, 2011. "Currency hedging failure in international equity investments and an efficient hedging strategy: The perspective of Korean investors," Pacific-Basin Finance Journal, Elsevier, Elsevier, vol. 19(4), pages 390-403, September.
  9. Mark E. Wohar & David E. Rapach, 2005. "Return Predictability and the Implied Intertemporal Hedging Demands for Stocks and Bonds: International Evidence," Computing in Economics and Finance 2005, Society for Computational Economics 329, Society for Computational Economics.
  10. Rapach, David E. & Wohar, Mark E., 2009. "Multi-period portfolio choice and the intertemporal hedging demands for stocks and bonds: International evidence," Journal of International Money and Finance, Elsevier, Elsevier, vol. 28(3), pages 427-453, April.
  11. De Nicolo, Gianni & Honohan, Patrick & Ize, Alain, 2003. "Dollarization of the banking system : good or bad?," Policy Research Working Paper Series 3116, The World Bank.
  12. Nicola Carcano, 2007. "Country and currency diversification of bond investments: do they really make sense for Swiss investors?," Financial Markets and Portfolio Management, Springer, vol. 21(1), pages 95-120, March.
  13. Gianni De Nicoló & Patrick Honohan & Alain Ize, 2003. "Dollarization of the Banking System," IMF Working Papers 03/146, International Monetary Fund.
  14. Benjamin H Cohen, 2005. "Currency choice in international bond issuance," BIS Quarterly Review, Bank for International Settlements, June.
  15. Carlos Eduardo Meyer dos Santos & Marcos Antonio C. da Silveira, 2010. "Depósitos Em Moeda Estrangeira Como Hedge Para Investidores Brasileiros De Longo Prazo: Uma Aplicação Da Teoria Da Escolha Estratégica De Portfólio," Discussion Papers 1462, Instituto de Pesquisa Econômica Aplicada - IPEA.

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