We analyze a large number of industry- and company-level filings of global institutional investors to provide the first comprehensive estimate of foreign investors' U.S. dollar (USD) security holdings and currency hedging practices. We document four stylized facts. First, driven by increasing portfolio allocations, foreign investors expanded their USD security holdings six-fold over the past two decades. Second, following the 2007-09 financial crisis, foreign mutual funds, insurers, and pensions raised their USD hedge ratio by an average of 15 percentage points, despite higher hedging costs implied by large and persistent deviations from covered interest-rate parity. The total FX hedging demand from these sector reached $2 trillion in 2019. Third, there is considerable heterogeneity in hedging practice across countries and sectors. Fourth, the global banking sector provides limited dollar hedging on net, underscoring the important role non-banks play in fulfilling the hedging demand of foreign institutional investors. We employ a mean-variance framework to benchmark investors' demand for USD assets and currency hedging practice, emphasizing the influence of expected returns on optimal portfolio construction and the apparent divergence between model predictions and observed hedging behaviors. We show a strong correlation between hedging demand and the cross-section of CIP deviations.
Authors
- Acknowledgements & Disclosure
- We thank William Diamond, Leonardo Elias (discussant) Narayana Kocherlakota, Ralph Koijen, Arvind Krishnamurthy, Karen Lewis, Olivia Mitchell, Robert Richmond (discussant), Nick Roussanov, Tom Sargent, Giorgia Simion (discussant), Emil Siriwardane (discussant), Adrien Verdelhan, Moto Yogo (discussant) and Tony Zhang (discussant) for helpful comments. We also thank seminar and conference participants at Baylor University, the Federal Reserve Board, George Washington University, MIT, Wharton, Bank of Canada Annual Economic Conference, Chicago Booth Asset Pricing Conference, the Fed Dollar Conference, NBER Insurance Spring Meeting, NBER Summer Institute IAP, OFR-Johns Hopkin Carey Finance Conference, and the Vienna FX Conference for helpful comments. We thank Zhiyu Fu, Srikkur Kanuparthy, Bailey Kraus, Simone Ricci, Laurenz De Rosa, Judy Yue, and Amy Zhang for outstanding research assistance. This research was funded in part by the Fama-Miller Center for Research in Finance at the University of Chicago Booth School of Business. All remaining errors are our own. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
- DOI
- https://doi.org/10.3386/w32453
- Published in
- United States of America
