Currency-Hedging Optimization for Multi-Asset Portfolios

Abstract

Institutional investors with global multi-asset portfolios often make currency-hedging decisions asset by asset rather than for the overall portfolio. Many impose uniform hedge ratios at the portfolio or asset level. The authors instead argue for portfolio-level currency-hedging optimization allowing currency-specific hedge ratios and propose an analytical framework based on marginal risk–return trade-offs to quantify and explain the efficiency loss due to the common practices. A mean-CVaR optimization framework is utilized to capture tail risk with non-normal returns. To emphasize the importance of base currency for the currency-hedging optimization, the authors perform sample optimizations for AUD-, JPY-, and USD-based investors.