The calculator uses the following parameters to calculate the hedge ratio:

 1. Transaction costs

     Increasing transaction costs means hedging is more expensive and therefore we want to hedge less. The more expensive the transaction costs the lower the hedge ratio.

 2. Currency volatility

 The greater the currency volatility, the more risky the “asset” becomes and the more we want to hedge.

 3. International allocation

 In general, the greater the international allocation of assets, the more we will want to hedge.

 4. Domestic correlation

 As currency becomes less correlated with domestic assets, we will want to hold more of it for diversification purposes, i.e. hedge less.

 5. International correlation

 As for domestic correlation, as currency becomes less correlated with international assets, we will want to hold more of it for diversification purposes, i.e. hedge less.

 6. Currency outlook

 If a currency has zero compound return, it must necessarily have positive arithmetic return on average (by Siegel’s paradox). Therefore we will want to have greater currency exposure if we expect a 0% compound return, resulting in a lower hedge ratio.

 7. Stock/Bond mix

 Bonds are held in greater proportion by risk-averse investors. Therefore, if the stock/bond ratio increases, it means we are becoming less risk averse and will want to hedge less.

8. Equity Premium

 This relates to the risk aversion coefficient. Equity premium here means the return spread between equity and bonds. An increasing equity premium enhances the relative attractiveness of equities. If our risk preferences remained the same, we would increase our exposure to equities. Because our mix is assumed constant, this means we have become more risk averse and therefore the hedge ratio goes up.