Selectively Hedging The Currencies When The PPP Puzzle Meets The Forward Premium Anomaly

This paper proposes a selective hedging strategy for managing foreign exchange risk which calls for hedging when a foreign currency is over-valued and the forward contract is trading at a premium but leaves the exposure uncovered otherwise. As empirical researches find that exchange rate deviations from the Purchasing Power Parity (PPP) are self-correcting and exchange rates often move to the opposite directions as implied in forward rate premiums or discounts, the intuitions of the strategy are to avoid predictable depreciations of over-valued currencies and to capture the benefits of forward premiums.