Working Paper: NBER ID: w13088
Authors: John Y. Campbell; Karine Serfaty-de Medeiros; Luis M. Viceira
Abstract: Over the period 1975 to 2005, the US dollar (particularly in relation to the Canadian dollar) and the euro and Swiss franc (particularly in the second half of the period) have moved against world equity markets. Thus these currencies should be attractive to risk-minimizing global equity investors despite their low average returns. The risk-minimizing currency strategy for a global bond investor is close to a full currency hedge, with a modest long position in the US dollar. There is little evidence that risk-minimizing investors should adjust their currency positions in response to movements in interest differentials.
Keywords: currency hedging; global equity investors; risk management
JEL Codes: F3; F31; G11; G12; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| long positions in currencies negatively correlated with equity returns (G15) | effective hedges (G14) |
| short positions in currencies positively correlated with equity returns (G15) | effective risk management (H12) |
| full currency hedge (F31) | effective risk management (H12) |
| high-beta currency pairs (F31) | increased returns for risk-taking (G11) |
| increases in interest rates (E43) | favoring currencies with high interest rates (F31) |
| currency returns are largely uncorrelated with bond returns (G15) | avoid holding foreign currencies (F31) |
| US dollar appreciates when bond prices fall (E43) | exception to the full hedge (Y60) |