1 STRATEGIC CURRENCY HEDGING AND GLOBAL PORTFOLIO INVESTMENTS: AN

The literature on the convenience of currency hedging of international portfolio investments has not reached a final verdict. There are arguments for [Perold and Schulman (1988)] and against it [Froot (1993) and Campbell, Viceira and White (2002)]. Here we analyze the perspective of global investors based in emerging markets, for which hedging should imply increasing expected returns. The question thus is whether currency hedging is a “free lunch ” in this case. It turns out that it is not. Hard currencies act as natural hedges against global (and local) portfolio losses, since they tend to appreciate with respect to emerging market currencies when the world portfolio return is negative. Therefore, in this case currency hedging increases volatility – but it also increases expected returns. We argue that this is likely to hold generally for relatively open economies with flexible exchange rate regimes. 2 1