Handbook of Exchange Rates

18.6 Conclusions

In this chapter, we investigated the historical performance of currency hedges in exposures to foreign government and high yield corporate bonds and equities. From a theoretical point of view, we establish that the volatility of fully hedged returns is lower than that of unhedged if the variance of forward points and their covariance with the underlying asset is lower than the variance of the currency exposure and the covariance between the foreign asset and the foreign currency. As the variance of the currency exposure is typically large, unhedged assets can only be less volatile than hedged if the covariance between the foreign asset and the foreign currency is strongly negative. In this case, the investor can use the positive relationship between its home currency and the foreign asset to offset moves in the foreign asset.

Historical results show that currency hedging has had a statistically significant effect of reducing volatility in exposures to foreign government bonds and US HY corporate bonds, with the exception of Canadian investors. The volatility reduction benefits of hedging equities have been mostly limited to exposures to Australia, Canada, and New Zealand.

Owing to the large volatility of currency and asset returns, we find that the return impact of currency hedging is typically not statistically significant. The return impact of hedging in government bonds has been small in comparison to the large reduction in volatility, leading to higher risk-adjusted ...