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Global currency hedging with common risk factors

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  • Opie, Wei
  • Riddiough, Steven J.

Abstract

We develop a novel method to dynamically hedge foreign exchange exposure in international equity and bond portfolios. The method exploits the time-series predictability of currency returns, which we show emerges from exploiting a forecastable component in global factor returns. The hedging strategy outperforms leading alternative approaches to currency hedging across a large set of performance metrics. Moreover, we find that exploiting currency return predictability via an independent currency portfolio delivers a high risk-adjusted return and provides superior diversification gains to global equity and bond investors relative to currency carry, value, and momentum investment strategies.

Suggested Citation

  • Opie, Wei & Riddiough, Steven J., 2020. "Global currency hedging with common risk factors," Journal of Financial Economics, Elsevier, vol. 136(3), pages 780-805.
  • Handle: RePEc:eee:jfinec:v:136:y:2020:i:3:p:780-805
    DOI: 10.1016/j.jfineco.2019.12.001
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    More about this item

    Keywords

    Global currency hedging; Currency risk factors; Currency returns; International portfolio diversification; Mean-variance optimization;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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