Should pension funds hedge currency risk? The case of Poland

Abstract

ABSTRACT In this study, we identify the optimal hedge ratio for mandatory pension funds, defining the optimum as the value that minimizes the portfolio variance in accordance with the social objective of the mandatory pension system. Unlike most previous studies, we apply a dynamic framework to account for a regular inflow of contributions and impose specific investment constraints that make the simulation more realistic. Our outcomes challenge the conventional knowledge concerning the need for currency hedging. We discover that in the case of Poland, shortening the currency positions is undesirable, as it amplifies the portfolio variance. Moreover, we provide evidence that pension funds should internationalize their portfolios even further to fully exploit the available diversification gains. Finally, the obtained simulation results are matched with real data. The comparison presented tends to beg the question of how to overcome the home bias phenomenon.