In an international economy where PPP is violated, the optimal strategy of a country-specific representative individual is shown to contain, in addition to the usual speculative component, only two hedging components, irrespective of the number of state variables. One is associated with the domestic interest rate risk and the other with the risk brought about by the co-movements of interest rates and the market prices of risk. Our decomposition leads to optimal (indirect) currency risk hedging.
LIOUI, A. and PONCET, P. (2000). International Asset Allocation: A New Perspective.