Working Paper: NBER ID: w24320
Authors: Nelson Camanho; Harald Hau; Hélène Rey
Abstract: We examine international equity allocations at the fund level and show how excess foreign returns influence portfolio rebalancing, capital flows and currencies. Our equilibrium model of incomplete FX risk trading where exchange rate risk partially segments international equity markets is consistent with the observed dynamics of equity returns, exchange rates, and fund-level capital flows. We document that rebalancing is more intense under higher FX volatility and find heterogeneous rebalancing behavior across different fund characteristics. A granular instrumental variable (GIV) approach identifies a positive currency supply elasticity.
Keywords: portfolio rebalancing; exchange rates; international finance; capital flows
JEL Codes: F3; F31; F32; F62; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| equity returns (G12) | capital flows (F32) |
| FX volatility (F31) | portfolio rebalancing (G11) |
| performance difference between foreign and domestic portfolio shares (G15) | portfolio rebalancing (G11) |
| fund size (G23) | portfolio rebalancing (G11) |
| capital flows (F32) | exchange rate movements (F31) |