Hedging with an Edge: Parametric Currency Overlay

39 Pages Posted: 18 Aug 2017 Last revised: 13 Dec 2017

See all articles by Pedro Barroso

Pedro Barroso

CATÓLICA-LISBON School of Business & Economics

Marco J. Menichetti

Liechtenstein University

Jurij-Andrei Reichenecker

Hochschule Liechtenstein - Institute of Financial Services

Date Written: November 16, 2017

Abstract

Campbell, Serfaty-De Medeiros, and Viceira (2010) propose an optimized method to hedge currency risk in portfolios of international equities. In a demanding out-of-sample test, incorporating transaction and rebalancing costs, and margin requirements we find their method reduces risk in real time, but also underperforms economically a naïve alternative or even a purely domestic portfolio. We propose modeling the currency hedging strategy as a function of characteristics proxying for expected returns and risk. We find that using currency momentum, value, carry, and autocorrelation significantly reduces the cost of hedging. Proxies for risk, such as volatility, skewness, beta on volatility, and equity sensitivity are irrelevant in our optimizations. Our optimal strategy is close to a fully hedged portfolio, but with a sizable 38% gain in Sharpe ratio.

Keywords: Foreign exchange, currency market, currency overlay.

JEL Classification: F31, G11

Suggested Citation

Barroso, Pedro and Menichetti, Marco Josef and Reichenecker, Jurij-Andrei, Hedging with an Edge: Parametric Currency Overlay (November 16, 2017). 30th Australasian Finance and Banking Conference 2017, Available at SSRN: https://ssrn.com/abstract=3020981 or http://dx.doi.org/10.2139/ssrn.3020981

Pedro Barroso

CATÓLICA-LISBON School of Business & Economics ( email )

Palma de Cima
Lisbon, Lisboa 1649-023
Portugal

HOME PAGE: http://https://clsbe.lisboa.ucp.pt/person/pedro-monteiro-e-silva-barroso

Marco Josef Menichetti

Liechtenstein University ( email )

Fürst-Franz-Josef-Strasse
Vaduz, FL-9490
Liechtenstein

HOME PAGE: http://www.uni.li

Jurij-Andrei Reichenecker (Contact Author)

Hochschule Liechtenstein - Institute of Financial Services ( email )

Liechtenstein

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
160
Abstract Views
1,156
rank
229,303
PlumX Metrics