International Economics and Economic Policy

, Volume 15, Issue 2, pp 281–303 | Cite as

Real financial market exchange rate volatility and portfolio flows

Original Paper
  • 43 Downloads

Abstract

This paper studies the relationship between real financial market exchange rate volatility and US cross-border equity flows. We found strong evidence that causality goes from real financial market exchange rate volatility to equity flows. According to our results, real financial market exchange rate volatility negatively influences purchases of foreign equity. This finding is in line with the portfolio optimization theory. The impact of real financial market exchange rate volatility on sales of foreign equity is also negative. This result can be explained by the theory of behavioral finance which states that investors are reluctant to realize losses of their portfolios. This is why investors decrease sales of assets when riskiness of the assets increases. The impact of real financial market exchange rate on net purchases of foreign equity is positive. It follows from these results that sales of foreign equity decrease more strongly than purchases of foreign equity when riskiness of foreign assets increases.

Keywords

Real financial market exchange rate Volatility Portfolio flows 

JEL classification

C33 E52 E58 F42 

Notes

Acknowledgments

I would like to thank Stefan Reitz for his valuable comments and suggestions as well as Lucio Sarno for the fruitful discussion on this research. I am grateful to participants of the 2015 Goettingen International Economic Relationships workshop, the May 2015 Economic Faculty Meeting at the University of Warsaw, the conference 2015 Spring Meeting of Young Economists and the 2015 European Economic and Finance Society conference for their comments and suggestions. Valuable suggestions from an anonymous referee of this journal are appreciated.

References

  1. Aguiar M, Gopinath G (2008) The role of interest rates and productivity shocks in emerging market fluctuations in current account and external financing. Central Bank of Chile, Chile, pp 345–367Google Scholar
  2. Albuquerque R, Bauer GH, Schneider M (2007) International equity flows and returns: a quantitative equilibrium approach. The Review of Economic Studies 74(1):1–30.  https://doi.org/10.1111/j.1467-937X.2007.00412.x CrossRefGoogle Scholar
  3. Almadi H, Rapach DE, Suri A (2014) Return predictability and dynamic asset allocation: how often should investors rebalance? The Journal of Portfolio Management 40(4):16–27CrossRefGoogle Scholar
  4. Andersen TG, Bollerslev T, Diebold FX, Labys P (2011) The distribution of realized exchange rate volatility. Journal of the American Statistical Association 96(453):42–55.  https://doi.org/10.1198/016214501750332965 CrossRefGoogle Scholar
  5. Asprem M (1989) Stock prices, asset portfolios and macroeconomic variables in ten European countries. Journal of Banking & Finance 13(4):589–612.  https://doi.org/10.1016/0378-4266(89)90032-0 CrossRefGoogle Scholar
  6. Auboin M, Ruta M (2013) The relationship between exchange rates and international trade: a literature review. World Trade Review 12(03):577–605.  https://doi.org/10.1017/S1474745613000025 CrossRefGoogle Scholar
  7. Baker HK, Filbeck G (2013) Portfolio theory and management. Oxford University Press, Oxford.  https://doi.org/10.1093/acprof:oso/9780199829699.001.0001 CrossRefGoogle Scholar
  8. Baum CF, Caglayan M (2010) On the sensitivity of the volume and volatility of bilateral trade flows to exchange rate uncertainty. Journal of International Money and Finance 29(1):79–93.  https://doi.org/10.1016/j.jimonfin.2008.12.003 CrossRefGoogle Scholar
  9. Baum CF, Caglayan M, Ozkan N (2004) Nonlinear effects of exchange rate volatility on the volume of bilateral exports. Journal of Applied Econometrics 19(1):1–23.  https://doi.org/10.1002/jae.725 CrossRefGoogle Scholar
  10. Bohn H, Tesar LL (1996) US equity investment in foreign markets: portfolio rebalancing or return chasing? The American Economic Review 86(2):77–81Google Scholar
  11. Bollerslev T (1986) Generalized autoregressive conditional heteroskedasticity. Journal of Econometrics 31(3):307–327.  https://doi.org/10.1016/0304-4076(86)90063-1 CrossRefGoogle Scholar
  12. Broner F, Didier T, Erce A, Schmukler SL (2013) Gross capital flows: dynamics and crises. Journal of Monetary Economics 60(1):113–133.  https://doi.org/10.1016/j.jmoneco.2012.12.004 CrossRefGoogle Scholar
  13. Brooks R, Edison H, Kumar MS, Sløk T (2004) Exchange rates and capital flows. European Financial Management 10(3):511–533.  https://doi.org/10.1111/j.1354-7798.2004.00261.x CrossRefGoogle Scholar
  14. Caglayan M, Di J (2010) Does real exchange rate volatility affect sectoral trade flows? Southern Economic Journal 77(2):313–335.  https://doi.org/10.4284/sej.2010.77.2.313 CrossRefGoogle Scholar
  15. Calvo GA, Leiderman L, Reinhart CM (1993) Capital inflows and real exchange rate appreciation in Latin America: the role of external factors. Staff Pap- Int Monetary Fund:108–151.  https://doi.org/10.2307/3867379
  16. Caporale GM, Ali FM, Spagnolo N (2015) Exchange rate uncertainty and international portfolio flows: a multivariate GARCH-in-mean approach. Journal of International Money and Finance 54:70–92.  https://doi.org/10.1016/j.jimonfin.2015.02.020 CrossRefGoogle Scholar
  17. Chuhan P, Claessens S, Mamingi N (1998) Equity and bond flows to Latin America and Asia: the role of global and country factors. Journal of Development Economics 55(2):439–463.  https://doi.org/10.1016/S0304-3878(98)00044-3 CrossRefGoogle Scholar
  18. Dvǒrak T (2003) Gross capital flows and asymmetric information. Journal of International Money and Finance 22(6):835–864CrossRefGoogle Scholar
  19. Engle RF (1982) Autoregressive conditional heteroscedasticity with estimates of the variance of United Kingdom inflation. Journal of the Econometric Society, Econometrica, pp 987–1007.  https://doi.org/10.2307/1912773 Google Scholar
  20. Evans MD, Lyons RK (1999) Order flow and exchange rate dynamics. Journal of Political Economy 110(1):170–180.  https://doi.org/10.1086/324391 CrossRefGoogle Scholar
  21. Evans MD, Lyons RK (2002a) Informational integration and FX trading. Journal of International Money and Finance 21(6):807–831.  https://doi.org/10.1016/S0261-5606(02)00024-4 CrossRefGoogle Scholar
  22. Evans MD, Lyons RK (2002b) Time-varying liquidity in foreign exchange. Journal of Monetary Economics 49(5):1025–1051.  https://doi.org/10.1016/S0304-3932(02)00124-1 CrossRefGoogle Scholar
  23. Ewing BT, Thompson MA (2007) Dynamic cyclical comovements of oil prices with industrial production, consumer prices, unemployment, and stock prices. Energy Policy 35(11):5535–5540.  https://doi.org/10.1016/j.enpol.2007.05.018 CrossRefGoogle Scholar
  24. Fernandez-Arias E (1996) The new wave of private capital inflows: push or pull? Journal of Development Economics 48(2):389–418.  https://doi.org/10.1016/0304-3878(95)00041-0 CrossRefGoogle Scholar
  25. Fidora M, Fratzscher M, Thimann C (2007) Home bias in global bond and equity markets: the role of real exchange rate volatility. Journal of International Money and Finance 26(4):631–655.  https://doi.org/10.1016/j.jimonfin.2007.03.002 CrossRefGoogle Scholar
  26. Forbes KJ, Warnock FE (2012) Capital flow waves: surges, stops, flight, and retrenchment. Journal of International Economics 88(2):235–251.  https://doi.org/10.1016/j.jinteco.2012.03.006 CrossRefGoogle Scholar
  27. Fratzscher M (2012) Capital flows, push versus pull factors and the global financial crisis. Journal of International Economics 88(2):341–356.  https://doi.org/10.1016/j.jinteco.2012.05.003 CrossRefGoogle Scholar
  28. Froot KA, Oconnell PG, Seasholes MS (2001) The portfolio flows of international investors. Journal of Financial Economics 59(2):151–193.  https://doi.org/10.1016/S0304-405X(00)00084-2 CrossRefGoogle Scholar
  29. Gelman M, Jochem A, Reitz S, Taylor MP (2015) Real financial market exchange rates and capital flows. Journal of International Money and Finance 54:50–69CrossRefGoogle Scholar
  30. Ghosh S, Reitz S (2013) Capital flows, financial asset prices and real financial market exchange rate: a case study for an emerging market, India. Journal of Reviews on Global Economics 2:158–171.  https://doi.org/10.6000/1929-7092.2013.02.13 Google Scholar
  31. Goldberg LS, Kolstad CD (1994) Foreign direct investment, exchange rate variability and demand uncertainty. Technical report, National Bureau of Economic Research w4815. doi: https://doi.org/10.2307/2527262
  32. Gorg H, Wakelin K (2002) The impact of exchange rate volatility on US direct investment. The Manchester School 70(3):380–397.  https://doi.org/10.1111/1467-9957.00308 CrossRefGoogle Scholar
  33. Griffin JM, Nardari F, Stulz RM (2004) Are daily cross-border equity flows pushed or pulled? The Review of Economics and Statistics 86(3):641–657.  https://doi.org/10.1162/0034653041811725 CrossRefGoogle Scholar
  34. Hau H, Rey H (2006) Exchange rates, equity prices, and capital flows. Review of Financial Studies 19(1):273–317.  https://doi.org/10.1093/rfs/hhj008 CrossRefGoogle Scholar
  35. Hau H, Rey H (2008) Global portfolio rebalancing under the microscope. Technical report, National Bureau of Economic Research w14165. doi: https://doi.org/10.2139/ssrn.1365266
  36. Hau H, Killeen W, Moore M (2002) How has the euro changed the foreign exchange market? Economic Policy 17(34):149–192.  https://doi.org/10.1111/1468-0327.00086 CrossRefGoogle Scholar
  37. Heimonen K (2009) The euro–dollar exchange rate and equity flows. Review of Financial Economics 18(4):202–209.  https://doi.org/10.1016/j.rfe.2009.01.001 CrossRefGoogle Scholar
  38. Hosseini SM, Ahmad Z, Lai YW (2011) The role of macroeconomic variables on stock market index in China and India. International Journal of Economics and Finance 3(6):p233.  https://doi.org/10.5539/ijef.v3n6p233 CrossRefGoogle Scholar
  39. Killeen WP, Lyons RK, Moore MJ (2006) Fixed versus flexible: Lessons from EMS order flow. Journal of International Money and Finance 25(4):551–579.  https://doi.org/10.1016/j.jimonfin.2005.11.011 CrossRefGoogle Scholar
  40. Kim KH (2003) Dollar exchange rate and stock price: evidence from multivariate cointegration and error correction model. Review of Financial Economics 12(3):301–313.  https://doi.org/10.1016/S1058-3300(03)00026-0 CrossRefGoogle Scholar
  41. Kiyota K, Urata S (2004) Exchange rate, exchange rate volatility and foreign direct investment. World Economics 27(10):1501–1536.  https://doi.org/10.1111/j.1467-9701.2004.00664.x CrossRefGoogle Scholar
  42. Klaassen F (2004) Why is it so difficult to find an effect of exchange rate risk on trade? Journal of International Money and Finance 23(5):817–839.  https://doi.org/10.1016/j.jimonfin.2004.03.009 CrossRefGoogle Scholar
  43. Kobberling V, Wakker PP (2005) An index of loss aversion. Journal of Economic Theory 122(1):119–131.  https://doi.org/10.1016/j.jet.2004.03.009 CrossRefGoogle Scholar
  44. Lamont OA, Thaler RH (2003) Anomalies: the law of one price in financial markets. The Journal of Economic Perspectives 17(4):191–202.  https://doi.org/10.1257/089533003772034952 CrossRefGoogle Scholar
  45. Lyons RK (2001) The microstructure approach to exchange rates. MIT Press, CambridgeGoogle Scholar
  46. McKenzie MD (1999) The impact of exchange rate volatility on international trade flows. Journal of Economic Surveys 13(1):71–106.  https://doi.org/10.1111/1467-6419.00075 CrossRefGoogle Scholar
  47. Menkhoff L, Sarno L, Schmeling M, Schrimpf A (2012) Carry trades and global foreign exchange volatility. The Journal of Finance 67(2):681–718.  https://doi.org/10.1111/j.1540-6261.2012.01728.x CrossRefGoogle Scholar
  48. Nasseh A, Strauss J (2000) Stock prices and domestic and international macro-economic activity: a cointegration approach. The Quarterly Review of Economics and Finance 40(2):229–245.  https://doi.org/10.1016/S1062-9769(99)00054-X CrossRefGoogle Scholar
  49. OECD (2013) Economic surveys: South Africa 2013. OECD Publishing.  https://doi.org/10.1787/eco_surveys-zaf-2013-en
  50. Taylor MP, Sarno L (1997) Capital flows to developing countries: long-and short- term determinants. The World Bank Economic Review 11(3):451–470.  https://doi.org/10.1093/wber/11.3.451 CrossRefGoogle Scholar
  51. Vayanos D (2004) Flight to quality, flight to liquidity, and the pricing of risk. Technical report, National Bureau of Economic Research w10327Google Scholar

Copyright information

© Springer-Verlag GmbH Germany, part of Springer Nature 2017

Authors and Affiliations

  1. 1.University of KielKielGermany

Personalised recommendations