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Asian Review of Financial Research, Vol., No..
pp.209~242
pp.209~242
Dynamic Hedging or Friendly Fire? Perils of Hedging Foreign Currency Risks
Jin-Wan Cho Korea University Business School
Taeyong Kim Morningstar Associates Korea
Woojin Kim Korea University Business School
In this paper, we analyze the effects of dynamic hedging on the performance of an open-ended fund. We first derive the differences of fund values between hedged and non-hedged funds when dynamic hedging scheme is used. We find that when the currency is negatively correlated with the asset value, the dynamic hedging actually increases the volatility of the hedged fund. In addition to this negative correlation, if the underlying asset return has a negative autocorrelation, dynamic hedging can reduce the value of the hedged fund even when the expected value of currency return is zero. Using a unique sample of 27 ¡®Siamese Twin¡¯ international mutual funds in Korea, which offer both hedge and nonhedge options, these theoretical implications are empirically tested and confirmed. Our findings are related to the findings in Campbell, Medeiros, and Viceira (2006), and we conclude that when the dynamic hedging is employed, correlation structure between asset and currency returns must be examined beforehand.
Jin-Wan Cho
Taeyong Kim
Woojin Kim
In this paper, we analyze the effects of dynamic hedging on the performance of an open-ended fund. We first derive the differences of fund values between hedged and non-hedged funds when dynamic hedging scheme is used. We find that when the currency is negatively correlated with the asset value, the dynamic hedging actually increases the volatility of the hedged fund. In addition to this negative correlation, if the underlying asset return has a negative autocorrelation, dynamic hedging can reduce the value of the hedged fund even when the expected value of currency return is zero. Using a unique sample of 27 ¡®Siamese Twin¡¯ international mutual funds in Korea, which offer both hedge and nonhedge options, these theoretical implications are empirically tested and confirmed. Our findings are related to the findings in Campbell, Medeiros, and Viceira (2006), and we conclude that when the dynamic hedging is employed, correlation structure between asset and currency returns must be examined beforehand.
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