The importance of hedging currency risk: Evidence from CNY and CNH

As the Chinese RMB internationalization process accelerates, Chinese institutions and investors are increasingly seeking to invest in overseas financial markets. Accordingly, Chinese investors have more opportunities to hold foreign assets in US dollars and face currency risk in their portfolios. In this paper, we investigate the difference between fully hedged and unhedged portfolios consisting of 10 different risky asset datasets from 2006 to 2014 from the perspective of Chinese investors. The empirical results show that the fully hedged portfolios have significantly higher Sharpe ratios than the unhedged ones. In terms of economic benefit, a risk-averse investor would be willing to pay more per year to construct the fully hedged portfolio. For instance, using the equal-weighted portfolio strategy, investors are willing to pay more than 7.2% and 3.3% annually to eliminate the RMB currency risk in terms of CNY and CNH, respectively. Moreover, according to the outcomes in subperiods and time-varying rolling estimations, we conclude that currency hedging in portfolio management will become increasingly important during RMB internationalization.