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GMO recently published on this ("The Case for Not Currency Hedging Foreign Equity Investments: A U.S. Investor’s Perspective" 1). The basic take-away is that anytime the company or ETF's underlying fundamentals should have nothing to do with the trading currency, it could make sense to not hedge. Think, in the simple case, of a company that is US domiciled ...

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There is an interesting relationship between currency hedging and the carry trade. It can be shown that currency hedging will add to returns iff the carry trade is profitable. The two are equivalent if you think it through. So for example in the past 20 years interest rates have been very low in Japan and it has been profitable to borrow in Japan and invest ...

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A famous article many years ago was The Free Lunch in Currency Hedging by Andre Perold (1988). [http://www.hbs.edu/faculty/Pages/item.aspx?num=5305 ] It showed that while currency hedging does not change long term returns, it does reduce volatility. Thus, for a mean variance investor, it could be beneficial. This is because FX is not much correlated with ...

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You are correct in your basic approach. Given the correlation matrix $\textbf{C}$ and standard deviation matrix $\textbf{S}$ where standard deviations occupy the diagonal and zeros the rest (i.e. $s_{i,j} = \sigma_i | i = j$ and $s_{i,j} = 0 | i \neq j$), the covariance matrix can be found as $\textbf{R} = \textbf{SCS}$. Then your portfolio standard ...

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There exist a lot of way to choose risk factors and the choice differs according to the kind of underlying assets. In your case, particularly, since the portfolio is composed by currencies, I would choose the risk factors mainly among all the macroeconomic variables available in your dataset or data provider. After that, to choose on which of them basing ...

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