RT Journal Article
SR Electronic
T1 The Fallacy of Currency Diversification: *How Zero Correlation Can Still Add Risk*
JF The Journal of Investing
FD Institutional Investor Journals
SP joi.2019.1.097
DO 10.3905/joi.2019.1.097
A1 Bush, Robert
A1 Chen, Jason
A1 Legunn, Eric
YR 2019
UL http://joi.pm-research.com/content/early/2019/07/27/joi.2019.1.097.abstract
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