Hedging currency risk: Does it have to be so complicated?

Abstract

The question of whether foreign investments should be systematically hedged against currency risk has not been clearly answered to date. Numerous theoretical and empirical studies have provided contradictory conclusions. This paper examines to what extent foreign bonds and equities are exposed to currency risk. Risk and return of different strategies are aggregated over five reference currencies for a period from 1985 to 2000. The advantage of this method is that the results do not depend much on the time period chosen. Empirical evidence confirms the hypothesis that currency hedging should be fully applied to foreign bonds, whereas foreign equities should not or only be partially hedged.Currency risk; hedging; fixed income; equity; optimal hedge ratio