Full-Scale Currency Hedging

Vol. 22, No. 2, 2024
by Megan Czasonis, Mark Kritzman and David Turkington

After years of spirited debate, most investors agree that to minimize the risk currencies add to a portfolio they should hedge its currency exposures based on its betas relative to the currencies to which it is exposed. However, this notion of hedging makes sense only if the betas reliably reflect the co-occurrences of the cumulative returns of the portfolio and currencies over the investor’s horizon. And this will be true only if the correlations of currencies with the portfolio and with each other are constant across the return intervals used to estimate them and stationary through time. Neither of these conditions holds empirically. The authors propose a new currency hedging technique called full-scale hedging, which explicitly considers the full distribution of horizon co-occurrences.