CARFPaper2HEDGINGCURRENCYRISKININTERNATIONALINVESTMENTANDTRADE.docx

CARFPaper2HEDGINGCURRENCYRISKININTERNATIONALINVESTMENTANDTRADE.docx

《CARFPaper2HEDGINGCURRENCYRISKININTERNATIONALINVESTMENTANDTRADE.docx》由会员分享，可在线阅读，更多相关《CARFPaper2HEDGINGCURRENCYRISKININTERNATIONALINVESTMENTANDTRADE.docx（25页珍藏版）》请在冰豆网上搜索。

CARFPaper2HEDGINGCURRENCYRISKININTERNATIONALINVESTMENTANDTRADE

HEDGINGCURRENCYRISKININTERNATIONALINVESTMENTANDTRADE

BYMASAKAZUARIKAWAANDARUNMURALIDHAR

November2006

FirstDraft–Pleasedonotquotewithoutpermission

Abstract

Internationalinvestingandtradehasoneunintendedconsequence;namely,thecreationofcurrencyriskwhichcausesthelocalcurrencyvalueoftheforeignreceivablesorinvestmentstofluctuatedramaticallybecauseofpurecurrencymovements.Theacademicliteratureoncurrencieshastypicallymisunderstoodcurrencyriskandsuggestedthatcurrencieshavenolongtermreturn,aredifficulttopredict,anddifficulttotakeadvantageofasthemarketsareextremelyliquid.Hence,typicalrecommendationsincludeeitherthatcompaniesandinvestorsshouldremovethisuncompensatedvolatilitybynaivelyhedgingbackintothebasecurrencyorleavingtheriskunhedged（whichisoftenmisinterpretedand,asaresult,leftunmanaged）.Theeffectivefinancialmanagementofsuchcashflowsorinvestmentsprovidesacompletelydifferentperspectiveasnaïvehedging（unhedging）ofcurrencyriskimpliesastrongviewthatthebasecurrencywillappreciate（depreciate）againsttheforeigncurrency.Moreover,thecurrencymarkethasmanynon-profitparticipantsandwhileexactcurrencylevelscannotbepredicted,thefuturedirectionofcurrenciescanbeanticipatedthroughrelativelysimplemodelsandnon-profitparticipantscanbeexploited.WedemonstratehowJapanesecorporationsandinvestorscandevelopamuchmorerobustandSMART（SystematicManagementofAssetsUsingaRulesBasedTechnique）approachtomanagecurrencyrisk,therebyaddingvaluefromcurrencyfluctuationswhilemanagingcurrencyrisk.Inshort,theycaneasilyimproveperformance,riskmanagementandgovernance.SuchtransactionsareeasytoimplementwithcurrencyforwardsandwhilethecurrentpaperfocusesonUSDexposures,amoregeneralmulti-currencyapproachcanbedevelopedforamorecomprehensiveanalysis.

SECTION1:

BACKGROUNDONHOWCURRENCYRISKISCREATEDBYINTERNATIONALINVESTMENTORTRADE

Currencyriskisthebaneofforeigninvestmentandtrade,astradingproductsorassetsinforeigncountriesautomaticallycreatesexposuretoforeigncurrencies,whichleftunmanagedcanhurtreturns.Forexample,consideraJapanesecompanywhichexportsaproducttoorhasaforeignsubsidiaryintheUnitedStates.WhentheproductissoldintheUnitedStates,inUSdollars,thoserevenuesorprofitsneedtobesentbacktoJapanandhenceundergoacurrencytransformation.Ifthepaymentisinstantaneous,thenthecompanycanconductaspotcurrencytransaction.However,ifthepaymentistobereceivedafteradelay,thenthereisuncertaintyastothefuturespotrateandhenceuncertaintyastotheJapaneseyenamountthatistobereceivedinthefuture.Wecanshowthisinasimplisticwayinequation

（1）.AriseinthevalueoftheUSdollarbetweenthetimeofsaleandactualremitancewillleadtoawindfallgaininyenterms,whereasadeclineinthevalueofthedollarwillcausealossinyenterms.

Cashflowinyen=CashflowinUSdollars+Appreciation/DepreciationofUSdollarsversusyenbetweentimeofsaleandactualremitance

（1）

Inasimilarvein,whenaJapaneseinvestorbuysassetsabroadsayintheUnitedStates,thefirsttransactionistoconvertJapaneseyenintoUSdollars,andthesedollarsarethenusedtopurchasestocks,bondsorrealestate.AsthevalueoftheinvestmentchangesovertimeinUSdollarterms,themark-to-marketJapaneseyenvalueoftheinvestmentisalsobeingaffectedbythedollar-yenexchangerate.Inasimplisticway,thereturnsonaforeigninvestmentcanbeexpressedasinequation

（2）andagain,anappreciationoftheUSdollarleadstoanadditionalreturninyenterms,whileadepreciationoftheUSdollarleadstoaloss.

ReturnsinJapaneseyen=ReturnsinUSdollars+Appreciation/DepreciationofUSdollarsversusyen

（2）

Currencyriskisthefluctuationoftheyen（orbasecurrency）valueofthecashfloworinvestmentandtypicallyanappreciationoftheUSdollar（foreigncurrency）isagoodrisk,whileadeclineisconsideredabadrisk.Currencyriskiseffectivelythetranslationriskofforeigninvestmentortradeactivityandcanleadtolargeswingsinperformance.Mostcorporationsandinvestorswouldbefoolishtonotacceptthegoodrisk,butwouldbenegligenttonoteliminatethebadrisk.Sinceinvestorsandcorporationshavehaddifficultyidentifyingwhethergoodorbadriskislikelytoresultinthefuture,thetendencyhasbeentotrytoeliminatethisriskentirely,becauseitisbelievedthatoverthelongterm,currencyriskisuncompensatedandthathedgingwasnotcostly（PeroldandSchulman___）.

Ifweconsideralongtermchartofthenumberofyenittakestopurchase1USdollar,Chart1tellsauniquestoryoftheyenappreciatinginvalueto1/3itsoriginalvalue.Onedollarpurchased360yenin1971;byNovember2006,thatvaluewascloserto117.Inotherwords,theUSdollarhasbeeninaseculardeclineagainsttheyenandhaslost2/3sofitsvalue–henceaJapaneseinvestorwouldbeinclinedtobelievethatUSdollarreceiptsorinvestmentsmustbehedged.Weprovidesomesummarystatisticsontheexchangeratefrom1971to2006andthemeanvalueis181withastandarddeviationof74.

Chart1:

YenperUSD,January1971–October2006

Source:

Data:

EcoWin/Reuters;AlphaEngine®

Series

Mean

Max

Min

Range

StdDev

Median

Mode

Skew

Kurtosis

Japan,Currency,JPY/USD,Close

180.46

358.4

81.16

277.2

74.3

141.81

301.11

0.60

-1.02

However,ifoneshouldexaminethedatafromtheperspectiveofthelast15years,aslightlydifferentpictureemerges.Chart2plotsthesameexchangeratefromJanuary1990–November2006,butnowthestoryisaverydifferentone.Notonlyistherangemuchsmaller,butthestandarddeviationislowerandthemeanvalueisverydifferentsuggestingthatasofNovember,theexchangerateisatitslongterm（approximately）15yearmean.Thefactthatwhenonelooksata15yearchartandseesanoscillationofthevalueofthecurrencyaroundameanlevelof117hasledmanytoconcludethatcurrencieshavenolongtermreturnandhenceonlyaddvolatilitytointernationaltradeandinvestment.

Chart2:

YenperUSD,January1990–October2006

Source:

Data:

EcoWin/Reuters;AlphaEngine®

Mean

Max

Min

Range

StdDev

Median

Mode

Skew

Kurtosis

Japan,Currency,JPY/USD,Close

117.19

159.76

81.16

78.6

13.43

116.6

108.37

0.4337

0.4095

SECTION2:

BASICCONCLUSIONSFROMTHEACADEMICLITERATURE

Thecaseforwhycurrenciesshouldhavenolongtermreturnismoresophisticatedthanjustlookingata15yearchartandconcludingthatitoscillatesaroundsomemeanvalue.Themostbasicpremiseoffinanceisthatthevalueofasecurityoranassetisequaltothediscountedpresentvalueofallfuturecashflows（attheappropriaterate）.Whileanexchangeratequalifiesasasecuritybecauseitistradeddaily,itgeneratesnocashflowlikeabond,offersnodividendlikeanequityandhasno“terminalvalue”asinanytypicalasset.Currencieshavebeentermeda“mediumofexchange”andhencewhiletradedlikeasecurity,theyarenotanassetinthetruesenseoftheword.Hence,oneshouldnotexpectexchangeratestohaveareturnastheyarejustthe“grease”toexchangeproductsacrossdifferentgeographicalborders.However,becausetherearevariousforcesthataffectthedemandandsupplyofcurrencies,currencyvalueschangedailytherebygeneratingareturn（positiveornegative）eventhoughtheoreticallytheyshouldnot.Hence,ifcurrenciesareinexcessdemandrelativetoagivenratebecauseofaninfluxofforeigninvestors,thecurrencywillappreciate,butthroughchangesininternationaltradeandinvestment,theassetsintheforeigncountrywillbeovervaluedleadingtoeitherareductionindemandoranincreaseinthequantitysuppliedleadingtoasubsequentdepreciation.

Thereisanextensiveliteratureoncurrenciesandwhytheyovershoottheirequilibriumvalues（e.g.,seeDornbusch1976;Yotopoulos,PanA.andYasuyukiSawada（2005）.Moreimportantly,accordingtotheBankforInternationalSettlements,thisisoneofthemostliquidmarketsintheworldwithoverYen200trilliontradeddaily,whichisgreaterthanthesumofallequitymarkettradesglobally（http:

//www.bis.org/）.Inaddition,manyresearchershavetriedtopredictfuturecurrencylevelsusingvariousstructuralandtimeseriesmodelsandhavecometotheconclusionthatcurrenciesareextremelyhardtoforecastandthatthesemodelsperformnobetterthanarandomwalkmodel（MeeseandRogoff1983）.Yetcoincidentally,RichardMeesewentontoheadcurrencyresearchatamajorassetmanagementcompanyanddevelopedsuccessfulmodelstomanagecurrencyrisk.TheMeese-Rogoffresulthasbeensubsequentlycontestedinmorerecentresearch（GuoandSavickas2005）.

Howhastheacademiccommunityrespondedintermsofadvicetoinvestors?

“In1988,AndrePeroldandEvanSchulman2advocatedafullyhedgedpositiononthebasisofforeigncurrencyrisknotofferingacommensuratereturn.Inwhattheydeema"freelunch",theyarguethatasaresultofitszerolong-termexpectedreturn,currencyriskcanberemovedwithouttheportfoliosufferinganyreductioninlong-termreturn”.Therefore,manyanalystsincorrectlycametotheconclusionthattheavailabilityofextremeliquidity（andhencelowbid-askspreads）,alongtermzeroreturnandanapparentlackofpredictivepowerofacademiccurrencymodel