Volatility and dynamic currency hedging

Jae-Beom Cho, Hong-Ghi Min and Judith Ann McDonald

Journal of International Financial Markets, Institutions and Money, 2020, vol. 64, issue C

Abstract: We propose a dynamic and efficient global currency portfolio that can significantly decrease the risk of an exogenous portfolio of world equities. We demonstrate that our dynamic conditional correlation model, which is an application of Engle (2002), can decrease the estimated return variance of a portfolio of global equities by about 20 percent relative to the static model of Campbell et al. (2010). The Euro, the US Dollar, the Swiss Franc, and the Japanese Yen all move in a manner opposite to the world equity market, implying that they are safe-haven currencies. However, since the US financial crisis, the importance of the Japanese Yen in a global currency portfolio has grown, whereas that of the Euro has diminished. Increases in foreign-exchange-market volatility and US stock-market volatility have increased the importance of safe-haven currencies in optimal currency portfolios, and the impact of foreign-exchange-market volatility is more significant than that of US stock-market volatility. We also find a spillover effect from both US stock-market and US foreign-exchange-market volatilities to the foreign-exchange-market volatility of other currencies.

Keywords: Dynamic optimal currency portfolio; Risk-management demand for currencies; Safe-haven currency; Global currency hedging; Stock-market volatility; Foreign-exchange- market volatility; US financial crisis (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (16)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:intfin:v:64:y:2020:i:c:s104244311930321x

DOI: 10.1016/j.intfin.2019.101163

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