Working Paper: CEPR ID: DP4862
Authors: Harald Hau; Massimo Massa; Jol Peress
Abstract: Do exchange rates react to exogenous capital movements? We explore this issue based on the redefinition of the MSCI international equity indices announced on 10 December 2000 and implemented in two steps on 30 November 2001 and 31 May 2002. The index changes implied major changes in the representation of different countries in the MSCI world index. Our event study shows a strong announcement effect in which countries with a decreasing equity representation vis-a-vis the US depreciated against the dollar. Around the two implementation dates, we find further systematic, but opposite, exchange rate effects, which can be interpreted as a result of excessive speculation on the first implementation date and insufficient speculation on the second date.
Keywords: Event study; Exchange rates; Global equity index funds; Limits of arbitrage
JEL Codes: F31; G12; G24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Exogenous capital flows triggered by MSCI index changes (F32) | Exchange rates (F31) |
| Countries with decreasing equity representation relative to US dollar (F31) | Depreciation around implementation dates (D25) |
| Index reallocation (C43) | Currency appreciation for upweighted countries (F31) |
| Index reallocation (C43) | Currency depreciation for downweighted countries (F31) |
| Excessive speculative behavior on first implementation date (D84) | Depreciation of currencies (F31) |
| Insufficient speculation on second implementation date (D84) | Currency appreciation (F31) |
| Limited resilience of foreign exchange market to capital flows (F32) | Impact on exchange rates (F31) |
| Negative coefficients in OLS regressions (C29) | Decrease in exchange rates for countries with increased index weight (F31) |