Objectives of hedging and optimal hedge ratios: US vs Japanese investors

Abstract

Assuming interdependence vs independence of the equity and currency markets, the hedging performances of the minimum-total return variance hedge (MTRVH) vs the minimum-return differential variance hedge (MRDVH) strategies are compared. Substantial interdependence between the two markets is observed. The MTRVH ratios yield the best risk/return tradeoffs in all cases, and they are smaller than the MRDVH ratios. The currency volatility ratio is introduced as an indicator of a natural hedge. The Japanese and US investors have potential to make gains from global diversification and currency hedging, but the Japanese investor benefits more than the US investor does. More hedging is needed for the Japanese investor due to the strong yen, some positive covariances and negative currency surprises.