Optimal Currency Hedging for International Equity Portfolios

Abstract

This study explores optimal currency exposures in international equity portfolios through the lens of a modified mean–variance optimization framework. We decomposed the optimal currency portfolio into a “hedge portfolio” that uses a dynamic risk model to minimize equity volatility and an “alpha-seeking portfolio” based on the well-documented currency styles of value, momentum, fundamental momentum, and carry. This method is an integrated and economically intuitive approach to currency management that simultaneously provides lower risk and higher returns than either hedged or unhedged benchmarks. Crucially, the solution is practical, with realistic and implementable leverage, turnover, and tail-risk characteristics.