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Strategic currency hedging and global portfolio investments upside down

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  • 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
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    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., pages 161-183.
    4. Edyta Stepien, 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, pages 266-276.
    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, pages 390-403.
    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.

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