Nº 21-60: Dynamic Currency Hedging with Non-Gaussianity and Ambiguity

This paper introduces a non-Gaussian dynamic currency hedging strategy for globally diversified investors with ambiguity. Assuming that ambiguity of a typical investor can be measured from market data, we associate it to non-Gaussianity of financial asset returns and compute an optimal ambiguity-adjusted mean-variance (dynamic) currency allocation. Next, we extend the filtered historical simulation method to numerically optimize an arbitrary risk measure, such as the expected shortfall. The out-of-sample backtest results show that the derived non-Gaussian dynamic currency hedging strategy outperforms the benchmarks of constant hedging and dynamic hedging with Gaussianity for all base currencies and net of transaction costs.