Currency Hedging for International Stock Portfolios

A General Approach

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Abstract

This paper tests whether hedging currency risk improves the performance of international stock portfolios. We use a generalized performance measure which allows for investor-dependencies such as different utility functions and the presence of nontraded risks. In addition we show that an auxiliary regression, similar to the Jensen regression, provides a wealth of information about the optimal portfolio holdings for investors for the non mean-variance case. This is analogous to the information provided by the Jensen regression about optimal portfolio holdings for the mean-variance case. Our empirical results show that static hedging with currency forwards does not lead to improvements in portfolio performance for a US investor that holds a stock portfolio from the G5 countries. On the other hand, hedges that are conditional on the current interest rate spread do lead to significant performance improvements. Also, when an investor has a substantial exogenous exposure to one of the currencies, currency hedging clearly improves his portfolio performance. While these results hold for investors with power utility as well as with mean-variance utility functions, the optimal hedge ratios for these investors are different.
Original languageEnglish
Place of PublicationTilburg
PublisherEconometrics
Number of pages35
Volume1999-123
Publication statusPublished - 1999

Publication series

NameCentER Discussion Paper
Volume1999-123

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Investors
Currency hedging
Mean-variance
Currency
Optimal portfolio
Utility function
Portfolio performance
Power utility
Hedging
Hedge
Performance improvement
Wealth
Empirical results
Currency risk
Performance measures
Interest rate spread
Static hedging
Optimal hedge ratio

Cite this

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title = "Currency Hedging for International Stock Portfolios: A General Approach",
abstract = "This paper tests whether hedging currency risk improves the performance of international stock portfolios. We use a generalized performance measure which allows for investor-dependencies such as different utility functions and the presence of nontraded risks. In addition we show that an auxiliary regression, similar to the Jensen regression, provides a wealth of information about the optimal portfolio holdings for investors for the non mean-variance case. This is analogous to the information provided by the Jensen regression about optimal portfolio holdings for the mean-variance case. Our empirical results show that static hedging with currency forwards does not lead to improvements in portfolio performance for a US investor that holds a stock portfolio from the G5 countries. On the other hand, hedges that are conditional on the current interest rate spread do lead to significant performance improvements. Also, when an investor has a substantial exogenous exposure to one of the currencies, currency hedging clearly improves his portfolio performance. While these results hold for investors with power utility as well as with mean-variance utility functions, the optimal hedge ratios for these investors are different.",
author = "{de Roon}, F.A. and T.E. Nijman and B.J.M. Werker",
note = "Pagination: 35",
year = "1999",
language = "English",
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series = "CentER Discussion Paper",
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}

Currency Hedging for International Stock Portfolios : A General Approach. / de Roon, F.A.; Nijman, T.E.; Werker, B.J.M.

Tilburg : Econometrics, 1999. (CentER Discussion Paper; Vol. 1999-123).

Research output: Working paperDiscussion paperOther research output

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AU - de Roon, F.A.

AU - Nijman, T.E.

AU - Werker, B.J.M.

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AB - This paper tests whether hedging currency risk improves the performance of international stock portfolios. We use a generalized performance measure which allows for investor-dependencies such as different utility functions and the presence of nontraded risks. In addition we show that an auxiliary regression, similar to the Jensen regression, provides a wealth of information about the optimal portfolio holdings for investors for the non mean-variance case. This is analogous to the information provided by the Jensen regression about optimal portfolio holdings for the mean-variance case. Our empirical results show that static hedging with currency forwards does not lead to improvements in portfolio performance for a US investor that holds a stock portfolio from the G5 countries. On the other hand, hedges that are conditional on the current interest rate spread do lead to significant performance improvements. Also, when an investor has a substantial exogenous exposure to one of the currencies, currency hedging clearly improves his portfolio performance. While these results hold for investors with power utility as well as with mean-variance utility functions, the optimal hedge ratios for these investors are different.

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