Simulating Currency Risk on Private Investments in Real Estate

Abstract

Executive Summary.International real estate investment performance is highly sensitive to currency fluctuations. While large professional investors hedge currency at the portfolio level, not by asset class or asset, smaller, specialist investors hedge at the individual asset level, facing considerable specific risk. Hedging products are ill suited to international real estate. This paper uses a Monte Carlo framework to examine hedging using combinations of currency swaps for the rental income and expected terminal value of an office investment. The study suggests that the currency swap strategy results in considerable reduction of the downside risk associated with currency fluctuations and produces superior risk-adjusted returns.