Working Paper: CEPR ID: DP15777
Authors: Andreas M. Fischer; Rafael P. Greminger; Christian Grisse; Sylvia Kaufmann
Abstract: This paper investigates time variation in the dynamics of international portfolio equity flows.We extend the empirical model of Hau and Rey (2004) by embedding a Markov regime-switchingmodel into the structural VAR. The model is estimated using monthly data from 1995 to 2018,on equity returns, exchange rate returns, and equity flows between the United States and advanced and emerging market economies. We find that the data favor a two-state model wherecoefficients and shock volatilities switch jointly. In the VAR for flows between the United Statesand emerging market economies, the estimated states match periods of low and high financialstress, both in terms of the timing of regime switching and in terms of their volatility characteristics. Our main result is that for equity flows between the United States and emerging marketsrebalancing dynamics differ between episodes of high and low levels of financial stress. A switchfrom the low- to the high-stress regime is associated with capital outflows from emerging markets. Once in the high-stress regime, the response of capital flows to exchange rates and stockprices is smaller than in normal (low-stress) periods.
Keywords: portfolio rebalancing; equity flows; exchange rates; financial stress; structural VAR; sign restrictions; regime switching
JEL Codes: F30; G11; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Financial stress (G51) | Capital outflows from emerging markets (F32) |
| High-stress regime (C62) | Reduced responsiveness to price shocks (E39) |
| Low-stress regime (C62) | Greater responsiveness to price shocks (E39) |
| Switch from low-stress regime to high-stress regime (E63) | Capital flows response to exchange rates and stock prices is smaller (F32) |