IDEAS home Printed from https://ideas.repec.org/a/eee/jbrese/v61y2008i6p657-668.html
   My bibliography  Save this article

Strategic currency hedging and global portfolio investments upside down

Author

Listed:
  • Walker, Eduardo

Abstract

The literature on the convenience of currency hedging of international portfolio investments has not reached a final verdict. There are arguments for (Perold and Schulman [Perold, A.F. and Schulman, E.C. (1988). The free lunch in currency hedging: implications for investment policy and performance standards, Financial Analysts Journal, May/June Vol. 44, No. 3: 45-52]) and against (Froot [Froot, K. (1993). Currency hedging over long horizons. NBER Working Paper 4355.] and Campbell et al. [Campbell, J.Y., Viceira, L.M. and White, J.S. (2003). Foreign currency for long-term investors. The Economic Journal, Volume 113, Number 486, (March), pp. C1-C25(1)]). This paper analyzes the perspective of global investors based in emerging markets, for which hedging should imply increasing expected returns. The question thus is whether currency hedging is a "free lunch" in this case. No free lunch exists, as it turns out. Hard currencies act as natural hedges against global (and local) portfolio losses, since they tend to appreciate with respect to emerging market currencies when the world portfolio return is negative. Therefore, in this case currency hedging increases volatility--although also increasing expected returns. This result is likely to hold generally for relatively open economies with flexible exchange rate regimes.

Suggested Citation

  • Walker, Eduardo, 2008. "Strategic currency hedging and global portfolio investments upside down," Journal of Business Research, Elsevier, vol. 61(6), pages 657-668, June.
    • Handle: RePEc:eee:jbrese:v:61:y:2008:i:6:p:657-668
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0148-2963(07)00241-X
    Download Restriction: Full text for ScienceDirect subscribers only

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Stulz, René M., 1984. "Optimal Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 19(02), pages 127-140, June.
    2. Solnik, Bruno, 1993. "Currency Hedging and Siegel's Paradox: On Black's Universal Hedging Rule," Review of International Economics, Wiley Blackwell, vol. 1(2), pages 180-187, June.
    3. John Y. Campbell & Luis M. Viceira & Joshua S. White, 2003. "Foreign Currency for Long-Term Investors," Economic Journal, Royal Economic Society, vol. 113(486), pages 1-25, March.
    4. Guillermo A. Calvo & Carmen M. Reinhart, 2002. "Fear of Floating," The Quarterly Journal of Economics, Oxford University Press, vol. 117(2), pages 379-408.
    5. Doukas, John & Hall, Patricia H. & Lang, Larry H. P., 1999. "The pricing of currency risk in Japan," Journal of Banking & Finance, Elsevier, vol. 23(1), pages 1-20, January.
    6. Bernanke, Ben & Gertler, Mark & Gilchrist, Simon, 1996. "The Financial Accelerator and the Flight to Quality," The Review of Economics and Statistics, MIT Press, vol. 78(1), pages 1-15, February.
    7. Glen, Jack & Jorion, Philippe, 1993. " Currency Hedging for International Portfolios," Journal of Finance, American Finance Association, vol. 48(5), pages 1865-1886, December.
    8. Hua, Ping, 1998. "On Primary Commodity Prices: The Impact of Macroeconomic/Monetary Shocks," Journal of Policy Modeling, Elsevier, vol. 20(6), pages 767-790, December.
    9. Eduardo Borensztein & Carmen M. Reinhart, 1994. "The Macroeconomic Determinants of Commodity Prices," IMF Staff Papers, Palgrave Macmillan, vol. 41(2), pages 236-261, June.
    10. Fama, Eugene F, 1990. " Stock Returns, Expected Returns, and Real Activity," Journal of Finance, American Finance Association, vol. 45(4), pages 1089-1108, September.
    11. Dimson, Elroy, 1979. "Risk measurement when shares are subject to infrequent trading," Journal of Financial Economics, Elsevier, vol. 7(2), pages 197-226, June.
    12. Choi, Jongmoo Jay & Hiraki, Takato & Takezawa, Nobuya, 1998. "Is Foreign Exchange Risk Priced in the Japanese Stock Market?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 33(03), pages 361-382, September.
    13. Krasker, William S., 1980. "The `peso problem' in testing the efficiency of forward exchange markets," Journal of Monetary Economics, Elsevier, vol. 6(2), pages 269-276, April.
    14. Kenneth A. Froot, 1993. "Currency Hedging over Long Horizons," NBER Working Papers 4355, National Bureau of Economic Research, Inc.
    15. Stanley Fischer, 2001. "Exchange Rate Regimes: Is the Bipolar View Correct?," Journal of Economic Perspectives, American Economic Association, vol. 15(2), pages 3-24, Spring.
    16. Matthew D. Merritt & Shaun K. Roache, 2006. "Currency Risk Premia in Global Stock Markets," IMF Working Papers 06/194, International Monetary Fund.
    17. Dumas, Bernard & Solnik, Bruno, 1995. " The World Price of Foreign Exchange Risk," Journal of Finance, American Finance Association, vol. 50(2), pages 445-479, June.
    18. De Santis, Giorgio & Gerard, Bruno, 1998. "How big is the premium for currency risk?," Journal of Financial Economics, Elsevier, vol. 49(3), pages 375-412, September.
    19. Lioui, Abraham & Poncet, Patrice, 2003. "International asset allocation: A new perspective," Journal of Banking & Finance, Elsevier, vol. 27(11), pages 2203-2230, November.
    20. Fernando Lefort & Eduardo Walker, 1999. "El Dólar Como Activo Financiero: Teoría y Evidencia Chilena," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 36(109), pages 1035-1066.
    21. Reinhart, Carmen & Borensztein, Eduardo, 1994. "The Macroeconomic Determinants of Commodity Prices," MPRA Paper 6979, University Library of Munich, Germany.
    22. Bekaert, Geert & Hodrick, Robert J, 1992. " Characterizing Predictable Components in Excess Returns on Equity and Foreign Exchange Markets," Journal of Finance, American Finance Association, vol. 47(2), pages 467-509, June.
    23. Eun, Cheol S & Resnick, Bruce G, 1988. " Exchange Rate Uncertainty, Forward Contracts, and International Portfolio Selection," Journal of Finance, American Finance Association, vol. 43(1), pages 197-215, March.
    24. Adler, Michael & Prasad, Bhaskar, 1992. "On Universal Currency Hedges," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 27(01), pages 19-38, March.
    25. Claessens, Stijn & Dasgupta, Susmita & Glen, Jack, 1995. "The cross-section of stock returns : evidence from emerging markets," Policy Research Working Paper Series 1505, The World Bank.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Fabio Filipozzi & Kersti Harkmann, 2014. "Currency hedge – walking on the edge?," Bank of Estonia Working Papers wp2014-5, Bank of Estonia, revised 10 Oct 2014.
    2. Varas, Felipe & Walker, Eduardo, 2011. "Optimal close-to-home biases in asset allocation," Journal of Business Research, Elsevier, vol. 64(3), pages 328-337, March.
    3. Cecilia Maya & Karoll Gómez, 2008. "What Exactly is "Bad News" in Foreign Exchange Markets? Evidence from Latin American Markets," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 45(132), pages 161-183.
    4. Edyta Stepien & Yuli Su, 2012. "International portfolios and currency hedging: viewpoint of Polish investors," Managerial Finance, Emerald Group Publishing, vol. 38(7), pages 660-677, June.
    5. Aggarwal, Raj & Chen, Xiaoying & Yur-Austin, Jasmine, 2011. "Currency risk exposure of Chinese corporations," Research in International Business and Finance, Elsevier, vol. 25(3), pages 266-276, September.
    6. 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, vol. 19(4), pages 390-403, September.
    7. Castaneda, Pablo & Rudolph, Heinz P., 2011. "Upgrading investment regulations in second pillar pension systems : a proposal for Colombia," Policy Research Working Paper Series 5775, The World Bank.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:jbrese:v:61:y:2008:i:6:p:657-668. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dana Niculescu). General contact details of provider: http://www.elsevier.com/locate/jbusres .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.