Working Paper | 1993

Currency Hedging Over Long Horizons

by K. A. Froot

Abstract

This paper reexamines the widely-held wisdom that the currency exposure of international investments should be entirely hedged. It finds that the previously documented ability of hedges to reduce portfolio return variance holds at short horizons, but not at long horizons. At horizons of several years, complete hedging not only does not lower return variance, it actually increases the return variance of many portfolios. Hedge ratios chosen to minimize long-run return variance are not only low, they also have no perceptible impact on return variance. The paper reports and explores these results, their apparent causes, and investigates their implications for hedging practice.

Keywords: currency; Hedging; asset pricing; transaction costs; Exchange rates; international finance; International Markets; Real exchange rate; Purchasing power parity; International Finance; Currency Exchange Rate; Asset Pricing; Investment; Globalized Markets and Industries;

Citation:

Froot, K. A. "Currency Hedging Over Long Horizons." NBER Working Paper Series, No. 4355, May 1993. (Featured in the NBER Digest, October 1993. Harvard University, April 1993.)