PT - JOURNAL ARTICLE
AU - Bush, Robert
AU - Chen, Jason
AU - Legunn, Eric
TI - The Fallacy of Currency Diversification: <em>How Zero Correlation Can Still Add Risk</em>
AID - 10.3905/joi.2019.1.097
DP - 2019 Jul 26
TA - The Journal of Investing
PG - joi.2019.1.097
4099 - http://joi.pm-research.com/content/early/2019/07/27/joi.2019.1.097.short
4100 - http://joi.pm-research.com/content/early/2019/07/27/joi.2019.1.097.full
AB - The empirical observation is well documented that currency exposure can add risk to an unhedged international equity portfolio. Extending that work, this article uses three manipulations of the standard portfolio risk equation to show (1) why currency acts as implicit leverage in a portfolio and can therefore increase risk, even under the assumption of zero correlation; (2) how, under an additional assumption, the portfolio risk equation reduces to the Pythagorean equation and that, by using that result, a simple proof can show that an unhedged international equity portfolio is always riskier than a hedged one; and (3) how the risk equation can be rearranged to give the “correlation breakeven” that an investor requires to be indifferent to hedging (or not hedging).TOPICS: Currency, developed markets, portfolio construction, risk management