Abstract
This paper investigates the efficacy of five selective hedging strategies using foreign exchange futures contracts. The strategies are based on the relative purchasing power parity (PPP) and the random walk hypotheses. At 12- and 3-month investment horizons, a strategy which calls for shorting futures when there is a large deviation of the value of the foreign currency above its relative PPP equilibrium outperforms, on average, all other strategies in terms of return-per-unit-of-risk. Furthermore, this strategy produced an efficient frontier to the north-west of the frontiers of the other strategies, over the greatest range of standard deviations.
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