Working Paper: NBER ID: w14165
Authors: Harald Hau; Hélène Rey
Abstract: Cross border capital flows and returns on assets are two key variables in international macroeconomics. Difficult endogeneity issues plague any analysis of their correlations in aggregate data. This paper examines the dynamics of international portfolios with a unique data set on the stock allocations of approximately 6,500 international equity funds domiciled in four different currency areas during a 5 year period. The disaggregated data structure allows us to examine the effect of realized returns on portfolio adjustments. Do managers rebalance their portfolios towards their desired weights or do they increase their exposure to appreciating assets? We find strong support for portfolio rebalancing behavior aimed at stabilizing exchange rate risk and equity risk exposure around desired levels. These findings are important for the new open economy macroeconomics models featuring endogenous portfolio choice. They should also help inform the burgeoning theoretical literature in macroeconomics and in finance that aims at modeling financial intermediaries.
Keywords: Portfolio Rebalancing; International Capital Flows; Asset Pricing Dynamics
JEL Codes: F3; F32; G11; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| foreign assets appreciate (F31) | fund managers sell foreign assets (G15) |
| 10% excess return on foreign assets (G15) | 0.466% capital shift towards domestic holdings (F21) |
| return differential of foreign and domestic equities (G15) | rebalancing measure (F32) |
| marginal risk contribution of individual stocks (G11) | rebalancing behavior at the stock level (G41) |
| overall portfolio risk change (G11) | rebalancing behavior at the stock level (G41) |
| size of funds (G23) | degree of active risk management (G11) |