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Foreign Currency for Long-Term Investors

  • Viceira, Luis
  • Campbell, John
  • White, Joshua

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 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. 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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File URL: http://dash.harvard.edu/bitstream/handle/1/3128708/campbellssrn_foreigncurrency.pdf
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Paper provided by Harvard University Department of Economics in its series Scholarly Articles with number 3128708.

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Date of creation: 2003
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Publication status: Published in The Economic Journal
Handle: RePEc:hrv:faseco:3128708
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Web page: http://www.economics.harvard.edu/

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  1. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  2. Chan, Yeung Lewis & Viceira, Luis & Campbell, John, 2003. "A Multivariate Model of Strategic Asset Allocation," Scholarly Articles 3163263, Harvard University Department of Economics.
  3. Ait-Sahalia, Y. & Brandt, M.W., 2001. "Variable Selection for Portfolio Choice," Papers 34, Manitoba - Department of Economics.
  4. Froot, Kenneth A. & Rogoff, Kenneth, 1995. "Perspectives on PPP and long-run real exchange rates," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 32, pages 1647-1688 Elsevier.
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  7. Charles Engel, 1995. "The Forward Discount Anomaly and the Risk Premium: A Survey of Recent Evidence," NBER Working Papers 5312, National Bureau of Economic Research, Inc.
  8. Merton, Robert C., 1971. "Optimum consumption and portfolio rules in a continuous-time model," Journal of Economic Theory, Elsevier, vol. 3(4), pages 373-413, December.
  9. Viceira, Luis & Campbell, John, 2001. "Who Should Buy Long-Term Bonds?," Scholarly Articles 3128709, Harvard University Department of Economics.
  10. Mark P. Taylor, 1995. "The Economics of Exchange Rates," Journal of Economic Literature, American Economic Association, vol. 33(1), pages 13-47, March.
  11. John Y. Campbell & Luis M. Viceira, 1999. "Consumption And Portfolio Decisions When Expected Returns Are Time Varying," The Quarterly Journal of Economics, MIT Press, vol. 114(2), pages 433-495, May.
  12. Baxter, M. & Jermann, U.J., 1993. "The International Diversification Puzzle is Worse than you Think," RCER Working Papers 350, University of Rochester - Center for Economic Research (RCER).
  13. William N. Goetzmann & Lingfeng Li & K. Geert Rouwenhorst, 2005. "Long-Term Global Market Correlations," The Journal of Business, University of Chicago Press, vol. 78(1), pages 1-38, January.
  14. Epstein, Larry G & Zin, Stanley E, 1991. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 263-86, April.
  15. Lothian, James R & Taylor, Mark P, 1996. "Real Exchange Rate Behavior: The Recent Float from the Perspective of the Past Two Centuries," Journal of Political Economy, University of Chicago Press, vol. 104(3), pages 488-509, June.
  16. Alan M. Taylor, 2002. "A Century Of Purchasing-Power Parity," The Review of Economics and Statistics, MIT Press, vol. 84(1), pages 139-150, February.
  17. Alberto Giovannini & Philippe Weil, 1989. "Risk Aversion and Intertemporal Substitution in the Capital Asset Pricing Model," NBER Working Papers 2824, National Bureau of Economic Research, Inc.
  18. George Chacko & Luis M. Viceira, 2005. "Dynamic Consumption and Portfolio Choice with Stochastic Volatility in Incomplete Markets," Review of Financial Studies, Society for Financial Studies, vol. 18(4), pages 1369-1402.
  19. repec:fth:harver:1421 is not listed on IDEAS
  20. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-87, September.
  21. Frankel, Jeffrey A & Rose, Andrew K, 1995. "A Panel Project on Purchasing Power Parity: Mean Reversion Within and Between Countries," CEPR Discussion Papers 1128, C.E.P.R. Discussion Papers.
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  25. Bottazzi, Laura & Pesenti, Paolo & van Wincoop, Eric, 1996. "Wages, profits and the international portfolio puzzle," European Economic Review, Elsevier, vol. 40(2), pages 219-254, February.
  26. G. M. Grossman & K. Rogoff (ed.), 1995. "Handbook of International Economics," Handbook of International Economics, Elsevier, edition 1, volume 3, number 3.
  27. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, vol. 14(3), pages 319-338, November.
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  29. Baillie, Richard T. & Bollerslev, Tim, 2000. "The forward premium anomaly is not as bad as you think," Journal of International Money and Finance, Elsevier, vol. 19(4), pages 471-488, August.
  30. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
  31. Bekaert, Geert & Wei, Min & Xing, Yuhang, 2007. "Uncovered interest rate parity and the term structure," Journal of International Money and Finance, Elsevier, vol. 26(6), pages 1038-1069, October.
  32. Kenneth A. Froot, 1993. "Currency Hedging over Long Horizons," NBER Working Papers 4355, National Bureau of Economic Research, Inc.
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  34. Campbell, John Y. & Viceira, Luis M., 2002. "Strategic Asset Allocation: Portfolio Choice for Long-Term Investors," OUP Catalogue, Oxford University Press, number 9780198296942, March.
  35. Solnik, Bruno H., 1974. "An equilibrium model of the international capital market," Journal of Economic Theory, Elsevier, vol. 8(4), pages 500-524, August.
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