This paper considers the strategic currency hedging optimization problem for institutional investors with globally diversified portfolios. We argue the currency hedging decision should be made at the portfolio level on a currency-by-currency basis. It is suboptimal to develop hedging strategies by asset or to impose uniform or asset-specific hedging constraints at the portfolio level. Extant research on currency hedging usually confines the analysis to single asset classes rather than multi-asset portfolios (see, for example, Perold and Schulman (1988), Campbell, Serfaty-de Medeiros and Viceira (2010), Schmittmann (2010)). As a result, the recommended currency hedging strategies based on these analyses are often asset-specific.¹ Some studies extend the analysis to the portfolio level but only consider uniform hedge ratios (Eun and Resnick (1988); Liu and Jacobsen (2014)). These approaches are also popular among practitioners globally.² We quantify the potential efficiency loss of these common approaches relative to the recommended one. In our sample optimizations for Australian and Japanese investors, adopting currency-specific hedge ratios can reduce conditional value at risk (CVaR) by up to 1.5% and 3%, respectively, without reducing the expected return of the portfolio.

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This article appeared in The Journal of Portfolio Management’s Multi-Asset Special Issue 2018. ©2018 IPR Journals. All rights reserved.