The Hedging Cost of Forgetting the Exchange Rate

Abstract

The safe-haven property of gold has been widely studied, although little attention has been paid to how exchange rate movements could affect hedging strategies. We analyse the exchange rate role in stock portfolios hedged with gold in several regions from the point of view of non-US and US investors, using vine copulas to model the relation between gold, stock and exchange rates.
We find a leading role played by exchange rate hedging stock losses, which outstrips the position of gold (index) in non-US (US) portfolios. The inclusion of the exchange rate can reduce the ES between 107 and 162 bps. An out-of-sample exercise supports our results.
The implications of this study go beyond risk management decisions. Regulatory and supervisory authorities might find tools to assess the performance of financial assets under market distress scenarios.