currency hedging and global portfolio investments the other side of the coin costs, benefits,...

CURRENCY HEDGING AND GLOBAL PORTFOLIO CURRENCY HEDGING AND GLOBAL PORTFOLIO INVESTMENTSINVESTMENTS

THE OTHER SIDE OF THE COINTHE OTHER SIDE OF THE COIN

Costs, benefits, optimal exposureCosts, benefits, optimal exposure

Eduardo WalkerEduardo Walker

Professor Professor School of BusinessSchool of Business

Pontificia Universidad Católica de ChilePontificia Universidad Católica de [email protected]@faceapuc.cl

Seminario Internacional FIAP “Perspectivas para la inversión Seminario Internacional FIAP “Perspectivas para la inversión de los fondos de pensiones”, Santiago, Mayo 18-19, 2006de los fondos de pensiones”, Santiago, Mayo 18-19, 2006

22

Pension funds in EMPension funds in EM-- 12% invested abroad -- 12% invested abroad

Source: www.fiap.cl

33

QuestionsQuestions

Is currency hedging convenient or desirable?Is currency hedging convenient or desirable?– Is the desirability just related to currency Is the desirability just related to currency

volatility?volatility?– Should their be a minimum (as for Chilean Should their be a minimum (as for Chilean

AFPs)?AFPs)?– How do we assess the costs and benefits of How do we assess the costs and benefits of

hedging and how do we determine the optimal hedging and how do we determine the optimal hedging ratio?hedging ratio?

Implicit perspective: Implicit perspective: strategicstrategic or policy asset or policy asset allocationallocation

44

ContentsContents

Consequences of a “full hedge”Consequences of a “full hedge”

Hedged versus unhedged variancesHedged versus unhedged variances– Explanations for their evolutionExplanations for their evolution– Empirical evidenceEmpirical evidence

Local investor dilemma: should we hedge?Local investor dilemma: should we hedge?– Global minimum variance portfolio perspectiveGlobal minimum variance portfolio perspective– Unrestricted optimal portfolio perspectiveUnrestricted optimal portfolio perspective

Conclusions and caveatsConclusions and caveats

55

Assume we invest in the World equity portfolio, should we Assume we invest in the World equity portfolio, should we

hedge the currency risk?hedge the currency risk? ( (To hedge or not to hedge…To hedge or not to hedge…))

UNHEDGED returnUNHEDGED return

HEDGED returnHEDGED return

BENEFITBENEFIT: We : We recoverrecover the risk premium implicit in short term local rates (which the risk premium implicit in short term local rates (which should include country and currency risk premia)should include country and currency risk premia)

COSTCOST: Does it have a cost? Does it increase : Does it have a cost? Does it increase riskrisk??– Does hedging Does hedging increaseincrease volatility volatility? (Total risk perspective)? (Total risk perspective)– Does hedging Does hedging increaseincrease the risk of our combined portfolio? the risk of our combined portfolio? (Porftolio risk (Porftolio risk

perspective)perspective)NO: we have a “free lunch”?NO: we have a “free lunch”?YES: we need a YES: we need a contextcontext to calibrate costs and benefits to calibrate costs and benefits

66

var(var(rrLL)/var()/var(rr) – Local Perspective) – Local Perspective

Var(Var(rrLL) )

– return variance of the MSCI World measured in LC return variance of the MSCI World measured in LC (UNHEDGED)(UNHEDGED)

Var(Var(rr) ) – return variance of the MSCI World measured in USD return variance of the MSCI World measured in USD (HEDGED)(HEDGED)

77

var(var(rrLL)/var()/var(rr))

(Rolling 60 months)(Rolling 60 months) CHILE

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

Dic-97

Jul-98

Feb-99

Sep-99

Abr-00

Nov-00

Jun-01

Ene-02

Ago-02

Mar-03

Oct-03

May-04

Dic-04

Jul-05

Feb-06

V(rL) / V(r )

COLOMBIA

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

Dic-97

Jun-98

Dic-98

Jun-99

Dic-99

Jun-00

Dic-00

Jun-01

Dic-01

Jun-02

Dic-02

Jun-03

Dic-03

Jun-04

Dic-04

Jun-05

Dic-05

V(rL) / V(r )

PERU

0.60

0.70

0.80

0.90

1.00

1.10

1.20

1.30

Dic-97

Dic-98

Dic-99

Dic-00

Dic-01

Dic-02

Dic-03

Dic-04

Dic-05

V(rL) / V(r )

88

var(var(rrLL)/var()/var(rr))

(Rolling 60 months)(Rolling 60 months) MEXICO

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

Dic-97

Jun-98

Dic-98

Jun-99

Dic-99

Jun-00

Dic-00

Jun-01

Dic-01

Jun-02

Dic-02

Jun-03

Dic-03

Jun-04

Dic-04

Jun-05

Dic-05

V(rL) / V(r )

BRAZIL

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

9.00

10.00

Dic-97

Jun-98

Dic-98

Jun-99

Dic-99

Jun-00

Dic-00

Jun-01

Dic-01

Jun-02

Dic-02

Jun-03

Dic-03

Jun-04

Dic-04

Jun-05

Dic-05

V(rL) / V(r )

ARGENTINA

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

Dic-97

Jun-98

Dic-98

Jun-99

Dic-99

Jun-00

Dic-00

Jun-01

Dic-01

Jun-02

Dic-02

Jun-03

Dic-03

Jun-04

Dic-04

Jun-05

Dic-05

V(rL) / V(r )

VENEZUELA

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

Dic-97

Jun-98

Dic-98

Jun-99

Dic-99

Jun-00

Dic-00

Jun-01

Dic-01

Jun-02

Dic-02

Jun-03

Dic-03

Jun-04

Dic-04

Jun-05

Dic-05

V(rL) / V(r )

99

What explains the relative variances?What explains the relative variances?

var(var(rrLL)/var()/var(rr) has had huge swings over time in the different countries ) has had huge swings over time in the different countries

We can write var(We can write var(rrLL) = var() = var(r+er+e) = var(r)+var(e)+2cov(r,e)) = var(r)+var(e)+2cov(r,e)

Defining Defining

ee = =cov(cov(rr,,ee)/var()/var(rr) )

““Beta” of exchange rate variations (LC/USD) with respect to the world stock Beta” of exchange rate variations (LC/USD) with respect to the world stock

market market

The “minus” sign is because Beta is in the foreigner’s (USD/LC) perspectiveThe “minus” sign is because Beta is in the foreigner’s (USD/LC) perspective

We obtain: var(We obtain: var(rrLL)/var()/var(rr) = 1 + var() = 1 + var(ee)/var()/var(rr) ) 2 2ee

So var(So var(rrLL)/var()/var(rr) can change because…) can change because…

– The relative volatility of the exchange rate does, orThe relative volatility of the exchange rate does, or

– The “Beta” of the exchange rate movesThe “Beta” of the exchange rate moves

Notice the differences in points of view…Notice the differences in points of view…

1010

var(var(rrLL)/var()/var(rr)) = 1 + = 1 + var(var(ee)/var()/var(rr)) - - 22ee

CHILE

-1.50

-1.00

-0.50

0.00

0.50

1.00

1.50

Dec-97 Jun-99 Dec-00 Jun-02 Dec-03 Jun-05

V(e) / V(r) V(rL) / V(r ) -2 b e

BRAZIL

-3.00

-2.00

-1.00

0.00

1.00

2.00

3.00

4.00

5.00


V(e) / V(r) V(rL) / V(r ) -2b e

COLOMBIA

-1.00

-0.50

0.00

0.50

1.00

1.50


V(e) / V(r) V(rL) / V(r ) -2b e

MEXICO

-1.50

-1.00

-0.50

0.00

0.50

1.00

1.50

2.00


V(e) / V(r) V(rL) / V(r ) -2b e

1111

var(var(rrLL)/var()/var(rr)) = 1 + = 1 + var(var(ee)/var()/var(rr)) - - 22eePERU

-0.50

0.00

0.50

1.00

1.50

2.00


V(e) / V(r) V(rL) / V(r ) -2b e

ARGENTINA

-1.00

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00


V(e) / V(r) V(rL) / V(r ) -2 b e

VENEZUELA

-2.00

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00


V(e) / V(r) V(rL) / V(r ) -2b e

1212

CommentsCommentsIn many countries we observe a trend towards higher currency In many countries we observe a trend towards higher currency betas with respect to world equity marketsbetas with respect to world equity markets– Higher betas lower the volatility benefits of hedging from the Higher betas lower the volatility benefits of hedging from the

perspective of emerging market based investorsperspective of emerging market based investors

In Chile, Venezuela and Argentina the volatility of the exchange In Chile, Venezuela and Argentina the volatility of the exchange rate relative to the world stock markets’ has increasedrate relative to the world stock markets’ has increased

In Brazil, Colombia and Mexico, the relative volatility has In Brazil, Colombia and Mexico, the relative volatility has decreaseddecreased

Hedging Hedging increasesincreases risk in Chile, Colombia and Mexico risk in Chile, Colombia and Mexico

Hedging Hedging reducesreduces risk in Brazil, Argentina and Venezuela… risk in Brazil, Argentina and Venezuela…– ……where global equity probably doesn’t make much sense at this where global equity probably doesn’t make much sense at this

point anywaypoint anyway

1313

Risk in a Portfolio perspective 1:Risk in a Portfolio perspective 1:Global minimum variance portfolios (GMV) measured in the Global minimum variance portfolios (GMV) measured in the LC of each countryLC of each country

Asset classesAsset classes– Global unhedged equity (MSCI World Index Free)Global unhedged equity (MSCI World Index Free)– Global hedged equityGlobal hedged equity

Implicit hedgeImplicit hedge

– Local equity (MSCI local indices)Local equity (MSCI local indices)Exclude local fixed income which by definition would be Exclude local fixed income which by definition would be (nearly) risk free(nearly) risk free

The question is whether when the GMV The question is whether when the GMV includes global equity and if hedging is includes global equity and if hedging is convenientconvenient

1414

Portfolio perspective 1:Portfolio perspective 1:Technical note -- Technical note -- Regression for obtaining Global minimum Regression for obtaining Global minimum variance portfolios (GMV) weightsvariance portfolios (GMV) weights

The local currency return of a dollar deposit is approximately The local currency return of a dollar deposit is approximately rrFF++eeLL Methodology for estimating Global Minimum Variance portfolio weights Methodology for estimating Global Minimum Variance portfolio weights using simple regressions, in general: Kempf and Memmel (2003) using simple regressions, in general: Kempf and Memmel (2003) An advantage is that we don’t need expected return estimates for these An advantage is that we don’t need expected return estimates for these results results The amount of hedging is implicitThe amount of hedging is implicit GLGL is the is the totaltotal investment in the global portfolio investment in the global portfolio PL PL is the total investment in the local portfoliois the total investment in the local portfolio– 1- 1- PLPL-- GL GL is actually is actually minus minus the hedged fractionthe hedged fraction

1515

Global Minimum Variance Portfolios (GMV)Global Minimum Variance Portfolios (GMV)(Evolution of weights, LC perspective)(Evolution of weights, LC perspective)

COLOMBIA

0%

30%

60%

90%

120%

Dic-96 Jun-98 Dic-99 Jun-01 Dic-02 Jun-04 Dic-05

% USD fixed income % LOCAL equity %GLOBAL equity

MEXICO

-80%

-40%

0%

40%

80%

120%



PERU

-40%

0%

40%

80%

120%



CHILE

-30%

0%

30%

60%

90%

120%



1616

Global Minimum Variance Portfolios (GMV)Global Minimum Variance Portfolios (GMV)(Evolution of weights, LC perspective) (Evolution of weights, LC perspective)

BRAZIL

-120%

-90%

-60%

-30%

0%

30%

60%

90%

120%

150%



VENEZUELA

-120%

-90%

-60%

-30%

0%

30%

60%

90%

120%

150%


% USD fixed income % LOCAL equity %GLOBAL equityARGENTINA

-60%

-30%

0%

30%

60%

90%

120%



1717

Lesson from the GMV perspectiveLesson from the GMV perspective

Most portfolios have positive net investment in dollar depositsMost portfolios have positive net investment in dollar deposits– As in As in negative net hedgingnegative net hedging

But only a few cases are meaningfulBut only a few cases are meaningful– Only Chile and Colombia GMVs include positive investment in global Only Chile and Colombia GMVs include positive investment in global

equity equity

– In Mexico and Peru GMVs include zero investment in global equityIn Mexico and Peru GMVs include zero investment in global equity

– In Brazil, Argentina and Venezuela GMVs include negative investment In Brazil, Argentina and Venezuela GMVs include negative investment in global equityin global equity

We could have positive hedged global weights and negative unhedged We could have positive hedged global weights and negative unhedged global weights, but the total is negativeglobal weights, but the total is negative

Frequent home biasFrequent home bias

LimitationLimitation: no one is supposed to purchase the minimum variance : no one is supposed to purchase the minimum variance portfolio, since it means having portfolio, since it means having infiniteinfinite risk aversion… risk aversion…

1818

Portfolio perspective 2:Portfolio perspective 2:Unrestricted optimizationUnrestricted optimization

We assume than an investor is fully invested in local equity We assume than an investor is fully invested in local equity portfolio (measured with the MSCI local indices in LC, portfolio (measured with the MSCI local indices in LC, rrPP))

We must combine optimally the local equity portfolio with a We must combine optimally the local equity portfolio with a combination of the hedged and unhedged global equity portfolios combination of the hedged and unhedged global equity portfolios ((rrLL** and and rrLL))

– The perspective is always local, measured in LCThe perspective is always local, measured in LC

The optimal combined portfolio is chosen to maximize the Sharpe The optimal combined portfolio is chosen to maximize the Sharpe ratio, from the local perspective:ratio, from the local perspective:

1919

Optimal hedging CHILE Optimal hedging CHILE Global risk premiumLocal risk premiumLocal currency beta 0 0.1 0.3 0.5

Global premium unhedged 5.50% 4.95% 3.85% 2.75%

MSCI-W unhedged (rL) 79.99% 67.95% 36.27% -12.30%

MSCI-W hedged (r ) 2.60% 12.02% 36.82% 74.85%

Total foreign 82.59% 79.97% 73.09% 62.54%

MSCI Chile (r p ) 17.41% 20.03% 26.91% 37.46%

Global risk premiumLocal risk premiumLocal currency beta 0 0.1 0.3 0.5

Global premium hedged 5.50% 4.95% 3.85% 2.75%


MSCI-W hedged (r ) -3.87% 4.69% 27.02% 60.65%

Total foreign 71.87% 68.45% 59.51% 46.05%

MSCI Chile (rp ) 28.13% 31.55% 40.49% 53.95%

5.50%5.50%

weight

5.50%6.50%

weight

PANEL A

PANEL B

2020

Optimal hedging CHILEOptimal hedging CHILE

MSCI-W hedged: r

MSCI-W unhedged:rL

MSCI-chile: rp

0.0%

2.5%

5.0%

7.5%

0% 5% 10% 15% 20%St. Dev.

premiumfrontier r rL rp CML

2121

Optimal hedging COLOMBIAOptimal hedging COLOMBIA




MSCI-W hedged (r ) -3.76% 16.59% 73.15% 169.45%

Total foreign 89.75% 88.77% 86.06% 81.45%

MSCI Colombia (r p ) 10.25% 11.23% 13.94% 18.55%

Global risk premiumLocal risk premiumLoca currency beta 0 0.1 0.3 0.5



MSCI-W hedged (r ) -5.72% 14.02% 68.51% 159.97%

Total foreign 86.21% 84.90% 81.27% 75.19%

MSCI Colombia (rp ) 13.79% 15.10% 18.73% 24.81%

5.50%5.50%

weight

6.50%

weight

5.50%

PANEL A

PANEL B

2222

Optimal hedging COLOMBIAOptimal hedging COLOMBIA

0.0%

2.5%

5.0%

7.5%

0% 5% 10% 15% 20% 25% 30%St. Dev.


2323

Optimal hedging BRAZILOptimal hedging BRAZIL



MSCI-W unhedged (rL) 36.59% 33.98% 28.11% 21.20%

MSCI-W hedged (r ) 66.14% 69.29% 76.34% 84.66%

Total foreign 102.74% 103.27% 104.46% 105.86%

MSCI Brazil (rp ) -2.74% -3.27% -4.46% -5.86%



MSCI-W unhedged (rL) 37.53% 34.94% 29.12% 22.25%

MSCI-W hedged (r ) 57.98% 60.83% 67.23% 74.78%

Total foreign 95.51% 95.76% 96.34% 97.02%

MSCI Brazil (rp ) 4.49% 4.24% 3.66% 2.98%

5.50%5.50%

weight

6.50%

weight

5.50%

PANEL A

PANEL B

2424

Optimal hedging BRAZILOptimal hedging BRAZIL

0.0%

2.5%

5.0%

7.5%

0% 5% 10% 15% 20% 25% 30%St. Dev.


2525

Conclusions – caveatsConclusions – caveatsConcentrate on the perspective of emerging market based investors (EMIs)Concentrate on the perspective of emerging market based investors (EMIs)Currency hedging has costs and bebefitsCurrency hedging has costs and bebefitsBenefits for EMIsBenefits for EMIs– recover the risk premium in local ratesrecover the risk premium in local rates

Costs for EMIsCosts for EMIs– for some countries hedging for some countries hedging increases increases riskrisk

Optimal hedging is usually a fraction of the total investment abroadOptimal hedging is usually a fraction of the total investment abroad– Could be 100%, or even aboveCould be 100%, or even above– Could be 0%, or even negativeCould be 0%, or even negative

From the perspective of a an emerging market investor (EMI), high observed currency betas imply From the perspective of a an emerging market investor (EMI), high observed currency betas imply that the foreign currency is a “Natural Hedge” against drops in global (and possibly local) portfolio that the foreign currency is a “Natural Hedge” against drops in global (and possibly local) portfolio valuesvalues– From the perspective of a developed market based investor higher currency betas increase the contribution From the perspective of a developed market based investor higher currency betas increase the contribution

EM currencies to global portfolio riskEM currencies to global portfolio risk

LimitationsLimitations– We implicitly assume that the investment horizon is short and that volatility (and Beta) are adequate We implicitly assume that the investment horizon is short and that volatility (and Beta) are adequate

measures of riskmeasures of risk– Some risks (peso problems) are not well reflected in short-term volatilities Some risks (peso problems) are not well reflected in short-term volatilities – Conclusions may also change if we change the investment horizonConclusions may also change if we change the investment horizon

CURRENCY HEDGING AND GLOBAL PORTFOLIO CURRENCY HEDGING AND GLOBAL PORTFOLIO INVESTMENTSINVESTMENTS

THE OTHER SIDE OF THE COINTHE OTHER SIDE OF THE COIN

Costs, benefits, optimal exposureCosts, benefits, optimal exposure

Eduardo WalkerEduardo Walker

Professor Professor School of BusinessSchool of Business

Pontificia Universidad Católica de ChilePontificia Universidad Católica de [email protected]@faceapuc.cl

Rio de Janeiro, April 27, 2006Rio de Janeiro, April 27, 2006

AppendixAppendix

Examples of hedging and the Examples of hedging and the arithmetics involvedarithmetics involved

2828

A special asset class – hedged foreign A special asset class – hedged foreign portfolio investmentportfolio investment

Question: what do we obtain if we invest abroad Question: what do we obtain if we invest abroad and partially hedge back to local currency the and partially hedge back to local currency the value of our foreign portfoliovalue of our foreign portfolioNecessary information: the Necessary information: the forward exchange forward exchange raterateExample: Example: – The initial exchange rate is 34.2 USD/LCThe initial exchange rate is 34.2 USD/LC

(LC is the local currency). (LC is the local currency). – We invested USD1 Mn in the S&P500. The S&P return was We invested USD1 Mn in the S&P500. The S&P return was

1.5%. 1.5%. – What is the return measured in local currency (LC) if:What is the return measured in local currency (LC) if:

We did not hedge and the final currency value was 33.5 USD/LCWe did not hedge and the final currency value was 33.5 USD/LCWe sell forward USD1000000 at 34.3 USD/LCWe sell forward USD1000000 at 34.3 USD/LC

2929

Initial Final Final FinalAmt. Invested Usd 1000000 1015000 1015000 1015000S&P 500 Return Usd 1.50% 1.50% 1.50%Amt. Hedged Usd 0 500000 1000000

Spot exchange rate Usd/LC 34.2 33.5 33.5 33.5

Spot exchange rate LC/Usd 0.02924 0.02985 0.02985 0.02985

Variation of spot rate

2.09% 2.09% 2.09%

Forward Exchange Rate

Usd/LC 34.3 34.3 34.3

Forward Exchange Rate

LC/Usd 0.02915 0.02915 0.02915

Variation of forward rate

-0.29% -0.29% -0.29%

Value of Investment in LC (Pre-hegde)

LC 29239.8 30298.5 30298.5 30298.5

Hedge Effect LC 0.0 -348.1 -696.2Value of Investment in LC

LC 29239.8 30298.5 29950.4 29602.3

Return LC 3.62% 2.43% 1.24%

Hedge…Hedge…

3030

Hedge...Hedge...

3131

(1) Result of the partially (1) Result of the partially hedged hedged investmentinvestment

rr return of the foreign investment, in USDreturn of the foreign investment, in USDrrFF USD risk free rateUSD risk free raterrLFLF LC risk free rateLC risk free raterrLL((hh)) ret. of foreign investment after hedging fraction ret. of foreign investment after hedging fraction hh of the initial investment, in LC of the initial investment, in LCrrLL = = rrLL((hh) with h=0) with h=0rrLL** = = rrLL((hh) con ) con hh=1+=1+rrFF

rrPP return of investing in local assets in LCreturn of investing in local assets in LCee exchange rate variation (Eexchange rate variation (E11/E/E00-1), measured as LC per USD-1), measured as LC per USD

3232

(2) From the covered interest rate (2) From the covered interest rate parity equation…parity equation…



3333

(1’) Replacing (2) in (1)…(1’) Replacing (2) in (1)…



3434

(3) Making (3) Making h h = 1+= 1+rrFF… (… (full full hedge)hedge)(A fundamental result)(A fundamental result)



3535

(3) Then, with (3) Then, with h h = 1+= 1+rrFF ( (full full hedgehedge)…)…

In terms of volatility, the simplest way of measuring hedging In terms of volatility, the simplest way of measuring hedging benefits is with the ratio var(benefits is with the ratio var(rrLL)/var()/var(rr))



3636

Annualized Standard DeviationsAnnualized Standard Deviations

• S(e): volatility of the exchange rate

• S(r): volatility of MSCI World

• S(rp,USD): volatility of local MSCI index in USD

• S(rp) : volatility of local MSCI index in LC

ARGENTINA

0%

10%

20%

30%

40%

50%

60%

70%


s(e) s(r ) s(rp, usd) s(rp)

VENEZUELA

0%

10%

20%

30%

40%

50%

60%

70%



BRAZIL

0%

10%

20%

30%

40%

50%

60%

70%



3737

Annualized Standard DeviationsAnnualized Standard Deviations

• S(e): volatility of the exchange rate• S(r): volatility of MSCI World• S(rp,USD): volatility of local MSCI

index in USD• S(rp) : volatility of local MSCI index

in LC

MEXICO

0%

10%

20%

30%

40%

50%



CHILE

0%

10%

20%

30%

40%



PERU

0%

10%

20%

30%

40%



COLOMBIA

0%

10%

20%

30%

40%

50%



3838

Total risk perspective: Total risk perspective: Relative Sharpe RatiosRelative Sharpe Ratios

Let us assume an international CAPM, with Let us assume an international CAPM, with being being the global equity risk premium (assumed at 5.5 percent). the global equity risk premium (assumed at 5.5 percent). – Risk premium in local interest rates (with respect to foreign USD Risk premium in local interest rates (with respect to foreign USD

interest rates): interest rates): ee..Notice that with Beta close to 0.5 the risk premium in local rates is Notice that with Beta close to 0.5 the risk premium in local rates is substantial, 2.75%!substantial, 2.75%!

– Risk premium of the global investment w.r.t. local interest rates Risk premium of the global investment w.r.t. local interest rates without hedge: (1-without hedge: (1-ee))

– Risk premium obtained with Risk premium obtained with full hedgefull hedge

3939

Relative Sharpe RatiosRelative Sharpe RatiosVENEZUELA

-

0.30

0.60

0.90

1.20


S / Sh

BRAZIL

-

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

1.00


S / Sh

CHILE

-

0.30

0.60

0.90


S / Sh

ARGENTINA

-

0.30

0.60

0.90

1.20


S / Sh

4040

Relative Sharpe RatiosRelative Sharpe RatiosMEXICO

-

0.40

0.80

1.20


S / Sh

PERU

-

0.40

0.80

1.20


S / Sh

COLOMBIA

-

0.30

0.60

0.90

1.20


S / Sh

4141

Lesson from the total risk perspectiveLesson from the total risk perspective

Sharpe ratios are generally lower without hedgingSharpe ratios are generally lower without hedgingThe possible lower risks of The possible lower risks of not hedgingnot hedging due to positive due to positive betas are more than compensated by:betas are more than compensated by:– High relative exchange rate volatility in some cases, andHigh relative exchange rate volatility in some cases, and– Not recovering (via hedging) the risk premium in local interest Not recovering (via hedging) the risk premium in local interest

ratesrates

Thus, we should hedge…Thus, we should hedge…Limitation: we are not considering our entire portfolioLimitation: we are not considering our entire portfolio– e.g., the contribution of hedging to the risk and return of the local e.g., the contribution of hedging to the risk and return of the local

investor’s portfolioinvestor’s portfolio

4242

eeCHILE

-0.100

0.000

0.100

0.200

0.300

0.400

0.500

0.600

0.700


b e b e + 2*s(b)

BRAZIL

-1.000

-0.500

0.000

0.500

1.000

1.500

Dic-97 Dic-98 Dic-99 Dic-00 Dic-01 Dic-02 Dic-03 Dic-04 Dic-05

b e b e + 2*s(b)

COLOMBIA

-0.200

-0.100

0.000

0.100

0.200

0.300

0.400

0.500


b e b e + 2*s(b)

MEXICO

-0.500

0.000

0.500

1.000

1.500


b e b e + 2*s(b)

Confidence intervals

4343

ee

VENEZUELA

-1.000

-0.500

0.000

0.500

1.000

1.500

2.000


b e b e + 2*s(b)

PERU

-0.500

-0.400

-0.300

-0.200

-0.100

0.000

0.100

0.200

0.300

0.400

0.500


b e b e + 2*s(b)ARGENTINA

-2.000

-1.500

-1.000

-0.500

0.000

0.500

1.000

1.500

2.000


b e b e + 2*s(b)

Confidence intervals

currency hedging and global portfolio investments the other side of the coin costs, benefits,...

Documents