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Global Currency Hedging with Common Risk Factors

Last Updated on 10 February, 2024 by Rejaul Karim

The distinguished research paper “Global Currency Hedging with Common Risk Factors,” authored by Wei Opie and Steven Riddiough, presents a pioneering approach to dynamically hedge foreign exchange exposure in international equity and bond portfolios.

Through the development of a novel method, the study capitalizes on the time-series predictability of currency returns, emerging from a forecastable component in global factor returns. This groundbreaking approach outperforms leading alternative methods of currency hedging across a diverse range of out-of-sample performance metrics, underscoring its transformative potential in global currency risk management.

Moreover, the analysis reveals that by harnessing currency return predictability via an independent currency portfolio, investors can enjoy high risk-adjusted returns and attain enhanced diversification benefits.

This promises to deliver superior results to global equity and bond investors, transcending the potential of conventional currency carry, value, and momentum investment strategies, and delineating a revolutionary paradigm in international portfolio diversification.

Abstract Of Paper

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 out-of-sample 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.

Original paper – Download PDF

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Author

Wei Opie
Deakin University – Deakin Business School

Steven Riddiough
University of Toronto

Conclusion

The profound research findings unveiled in “Global Currency Hedging with Common Risk Factors” by Wei Opie and Steven Riddiough underscore a transformative breakthrough in dynamically hedging foreign exchange exposure in international equity and bond portfolios.

The innovative method developed capitalizes on the inherent time-series predictability of currency returns, stemming from exploit able forecastable elements in global factor returns, thereby outperforming established currency hedging approaches across an extensive array of out-of-sample performance metrics.

Furthermore, by leveraging currency return predictability through an independent currency portfolio, investors can attain high risk-adjusted returns and unravel superior diversification gains, transcending the potential of conventional currency carry, value, and momentum investment strategies.

This transformative potential not only promises to redefine currency risk management but also to enrich the realm of global equity and bond investment, offering a distinctive and potent avenue for international portfolio diversification.

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Is Currency Momentum a Hedge for Global Economic Risk?

FAQ

Q1: What is the main focus of the research paper “Global Currency Hedging with Common Risk Factors” by Wei Opie and Steven Riddiough?

A1: The main focus of the research paper is the development of a novel method for dynamically hedging foreign exchange exposure in international equity and bond portfolios. The method aims to exploit the time-series predictability of currency returns, which is shown to emerge from a forecastable component in global factor returns.

Q2: What distinguishes the developed hedging strategy in the study from alternative approaches to currency hedging?

A2: The developed hedging strategy in the study distinguishes itself by exploiting the time-series predictability of currency returns. It leverages a forecastable component in global factor returns, leading to outperformance compared to leading alternative approaches to currency hedging across a wide range of out-of-sample performance metrics.

Q3: How does the study suggest investors can benefit from the developed method of currency hedging?

A3: The study suggests that by exploiting currency return predictability through an independent currency portfolio, investors can achieve high risk-adjusted returns. Additionally, the method provides superior diversification gains to global equity and bond investors compared to traditional currency carry, value, and momentum investment strategies.

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