Alternative Currency Hedging Strategies with Known Covariances

Wei Chen, Mark Kritzman and David Turkington

Informed investors recognise that hedging at least some of a portfolio’s currency exposure, in most cases, improves its quality, although the best approach for doing so is not often obvious. This chapter presents a comprehensive analysis of the costs and benefits of a wide range of currency hedging strategies in order to facilitate ex ante comparison, and to help investors choose the strategy that best suits their goals. We first consider a range of linear hedging strategies that hedge a constant fraction of a portfolio’s explicit and implicit currency exposure, before examining strategies that employ options to hedge currency risk based on a variety of contingencies.¹¹A further extension is to examine the strategies that combine both currency forwards and currency options together, using full-scale optimisation based on Cremers et al. (2005). For details, please refer to Chen et al. (2015).

Our results are intended to provide an ex ante comparison of currency hedging strategies. In other words, we focus on the task of selecting an appropriate strategy when the covariance structure of the assets is known. The benefit of ex ante analysis is that we can consider the full