have begun to diversify their portfolios by moving some holdings to international equity and fixed income markets. This strategy can enhance a portfolio's risk-adjusted performance, but it also exposes investors to exchange rate fluctuations. Consequently, investors not only must choose strategic (or long-term) foreign asset allocations, they also must decide on a policy for managing currency exposure. An equilibrium approach to strategic asset allocation provides investors with key insights regarding both the level of international diversification and the corresponding level of currency hedging. For example, as we have seen, in equilibrium all investors would hold global assets in their capitalization weight proportions. In reality, while investors have been increasing their international holdings over time, it is still the case that on average most investors globally are overweight domestic securities. Thus, it becomes more important to understand what are rational reasons for deviating from holding the market portfolio and what are the potential costs of doing so. In this chapter, we'll first explore the issue of international diversification. Judged from a different perspective, we'll discuss the introduction of home bias in an investor's portfolio. (Home bias is the tendency for investors to hold a disproportionate level of their investments in the domestic market.) After discussing home bias, we'll turn our attention to the issue of strategic currency hedging. We'll start by looking at the impact of currency hedging on individual asset classes, and then consider what an equilibrium currency hedge ratio should look like. After developing the equilibrium hedge ratio, we'll explore the impact of home bias on the currency hedge ratio. Our results are very straightforward and make intuitive sense. First, we find that a moderate degree of home bias is not particularly costly in terms of the risk it creates. Second, we find that investors should distinguish between asset classes when making currency hedging decisions: Basically, foreign bond holdings should be hedged at the 100 percent level, while the hedge ratio for foreign equities depends on the level of home bias in the portfolio.