Optimal currency hedge and the carry trade
Review of Accounting and Finance
ISSN: 1475-7702
Article publication date: 24 August 2020
Issue publication date: 20 October 2020
Abstract
Purpose
This paper aims to investigate the efficiency of different hedging strategies for an investor holding a portfolio of foreign currency bonds.
Design/methodology/approach
The simplest strategies of no hedge and fully hedged are compared with the more sophisticated strategies of the ordinary least squares (OLS) approach and the optimal hedge ratios found by the dynamic conditional correlation-generalised autoregressive conditional heteroskedasticity approach.
Findings
The sophisticated hedging strategies are found to be superior to the simple strategies because they lower the portfolio risk in domestic currency terms and improve the Sharpe ratios for multi-asset portfolios. The analyses also show that both the OLS and dynamic hedging strategies imply holding a limited carry position by being long in high-yielding currencies but short in low-yielding currencies.
Originality/value
The performance of multi-currency portfolios is examined using more realistic assumptions than in the previous literature, including a weekly frequency and a constraint of no short selling. Furthermore, carry trades are shown to be part of an optimal portfolio.
Keywords
Citation
Filipozzi, F. and Harkmann, K. (2020), "Optimal currency hedge and the carry trade", Review of Accounting and Finance, Vol. 19 No. 3, pp. 411-427. https://doi.org/10.1108/RAF-10-2018-0219
Publisher
:Emerald Publishing Limited
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