INVESTING IN EMERGING STOCK MARKETS - IS IT WORTHWHILE HEDGING FOREIGN-EXCHANGE RISK

This article investigates the role played by currency risk in determin ing the benefits from international diversification in developed and e merging stock markets. While previous studies examine the advantage of international diversification because of low correlations between the returns of developed and emerging markets, they do not consider the u nique role of currency risk on the overall risk exposure in emerging m arkets. The authors' findings indicate that only investors who tolerat e high levels of risk can gain by diversifying into emerging markets. They further indicate that in such diversification, the hedging of cur rency risk is an inferior policy because of the negative correlations between the exchange rate and stock returns when measured in the local currencies of emerging markets.