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Benchmarking and Currency Risk

Published online by Cambridge University Press:  10 June 2016

Massimo Massa ,
Yanbo Wang  and
Hong Zhang
Massimo Massa
Affiliation:
[email protected], INSEAD, Fontainebleau, 77305 Cedex, France
Yanbo Wang
Affiliation:
[email protected], Sungkyunkwan University, Graduate School of Business, Seoul 110-745, Korea
Hong Zhang*
Affiliation:
[email protected], Tsinghua University, PBC School of Finance, Beijing 100083, China.
*
*Corresponding author: [email protected]
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Abstract

We show that the currency risk embedded in the benchmarks of international mutual funds negatively affects fund performance. More specifically, a high benchmark-implied currency risk induces funds to invest in markets with less volatile currencies, leading to a higher degree of currency concentration in portfolio holdings. This currency concentration, however, departs from the optimal equity allocation strategy across countries and reduces fund performance. We document that funds resorting to high currency concentrations underperform funds with low currency concentrations by as much as 1%–2% per year.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 51 , Issue 2 , April 2016 , pp. 629 - 654
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2016 

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