Examination of empirical theory about currency movements and risk hedging of portfolios.
By Christian Betz, Jyske Capital
The purpose of this article is to describe and compare scientific articles dealing with the impact of currency movements on portfolios of foreign assets and the effect of currency risk hedging on portfolio risk and return. Argumentation and conclusions are based on empirical theory.
Currency risk is an inevitable part of investing in assets in a currency other than the investor’s base currency, and there are diverging views of how to handle such risk. Currency risk can on the one hand be seen as uncompensated risk which investors may benefit from hedging away, for instance via a currency overlay programme. On the other hand, currency risk can be seen as risk which for certain assets, such as equities, is of less importance and which over time tends towards being offset.
The purpose of this article is to gather considerations and conclusions on this issue from various research papers. Including what seems to be consensus with respect to the handling of currency risk on bonds and equities as well as mixed portfolios. This should be seen in the light of the rising interest in currency overlay programmes and the derived considerations about the degree of hedging. A considerable part of the literature is based on the dollar as base currency whereas a few consider the risk from the point of view of a DKK investor. The article focuses exclusively on the issue taking its point of departure in academic empirical theory. In a subsequent article we will with our own calculations deal with the issue from a quantitative angle seen from a Danish investor’s point of view.