The Currency Conundrum: Regret Versus Optimal Hedging

Mark Anson

Currency risk has long bedeviled investors, with many opinions and recommendations as to whether investors should ever hedge their currency exposure.¹¹See, for example, Schmittman (2010), Froot (1993), Glen and Jorion (1993) and Perold and Schulman (1988). Even this author has previously taken a stab at trying to solve the currency conundrum (Anson 2002). Unfortunately, there is no easy answer and the debate over the best currency strategy continues. Taking a step back, currency risk is fascinating because it is a by-product of international investing. Currency has no long-term expected return because, although it is a risk exposure, it is not an economic asset for which a long-term risk premium exists. Investors do not invest in currencies to capture a risk premium; instead, they invest in international assets denominated in a foreign currency. As a result, investors received currency exposure as a side effect of their internationally diversified investment portfolios.

Currency risk can best be described as the surprise impact that currency exposure has on an investment portfolio. Although currency risk typically confounds investors, it is easy to measure – it is the difference