The hedging of currency risk for U.S. equity investors

Abstract International investing has increased in popularity, and currency risk is an important component in the investing decision. Despite this, there is little definitive guidance for equity investors as to how to hedge currency risk. In practice, the degree to which currency risk should be hedged depends partly on the correlation between the currency and stock returns. This correlation varies substantially within and between developed and emerging markets and depends on an economy's characteristics. Unlike in most previous studies, we use a simple, easily implemented ex‐ante risk‐minimizing hedge ratio and show that, ex‐post, it usually results in lower risk than a full hedge or other heuristic hedge ratios. In developed countries (but not in emerging markets), this ex‐post risk reduction is achieved without reducing mean returns.