EFFECTS OF ARTIFICIAL AND NATURAL HEDGING ON INTERNATIONAL REAL ESTATE INVESTMENTS

Abstract

With the recent onset of the Global Financial Crisis, investors have to rethink their hedging strategies across diversified portfolios as well as with portfolios with longer investment horizons, to seek the best risk-return characteristics. The purposes of this study are to 1) determine if the currency swap strategy dominates the natural hedge strategy over a 3 year, 5 year and 7 year holding period by their risk-return characteristics (Sharpe ratio, Treynor’s Ratio, Jensen’s alpha) during a period of both calm and crisis (Q4 2001 to Q2 2012); 2) to determine if the currency swap strategy dominates the natural hedge strategy on the basis of maximal utility and risk averseness (stochastic dominance) during a period of both calm and crisis; 3) to determine if the currency swap strategy dominates the natural hedge strategy on the basis of risk-return characteristics, maximal utility and risk averseness during the GFC. The findings proved contrary that the natural hedge strategy dominated the currency swap strategy over the three holding periods and during the GFC period. The natural hedge strategy dominated on all accounts of risk-return characteristics, maximal utility and risk averseness. This is primarily to the US Dollar weakening during the period of study, and thus, the natural hedge strategy provided better portfolio diversification than the currency swap’s ability to mitigate currency risk. Studies involving correlations between currencies in the portfolio and real estate returns and comparing specific holding periods during the GFC with general trends could be conducted to improve the measure of hedging.