The Performance of Currency Hedge Funds and Foreign Exchange Risk Premia

This study investigates the performance and risk of currency hedge funds from 1999 to 2009. Our results show that a substantial number of hedge funds generate returns that exceed foreign exchange risk premia obtained through carry trades. Small funds perform better than large funds and the best alpha-generating funds exhibit a performance that persists over a one-year horizon. This performance persistence is associated with currency risk-related factors and, only for the best-performing funds, is due to the remuneration for active management skills. JEL classi…cation: F31; F37. Keywords: hedge funds, foreign exchange; asset allocation, funds performance evaluation. Acknowledgments: This work was partly written while Giorgio Valente was visiting the Federal Reserve Bank of St. Louis and the Hong Kong Institute for Monetary Research, whose hospitality is gratefully acknowledged. The authors also thank Pasquale della Corte, Nikolaus Hatsch, Richard Levich, Mike McCraken, Lukas Menkho¤, Chris Neely, Momtchil Pojarliev, Maik Schmeling, Lucio Sarno, and Ilias Tsiakas for useful conversations and comments on an earlier draft of this paper and the seminar participants at the Bank for International Settlements, Humboldt University, University of Hannover, University of Essex, Korea University Business School and the 2010 Asian Finance Association Meetings, Hong Kong, the 5th Conference on Asia-Paci…c Financial Markets, Seoul. The authors alone are responsible for the views expressed and any errors that may remain. yGiorgio Valente (corresponding author), Essex Business School, University of Essex, Colchester CO4 3SQ, UK. Phone: +44-1206-872254. E-mail: [email protected]. Federico Nucera, Bocconi University, Milan, Italy, E-mail: [email protected].