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Do Demand Curves for Currencies Slope Down? Evidence from the MSCI Global Index Change

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  • Harald Hau
  • Massimo Massa
  • Joel Peress

Abstract

Traditional portfolio balance theory derives a downward sloping currency demand function from limited international asset substitutability. Historically, this theory enjoyed little empirical support. We provide direct evidence by examining the exchange rate effect of a major redefinition of the MSCI Global Equity Index in 2001 and 2002. The index redefinition implied large changes in the representation of different countries in the MSCI Global Equity Index and therefore produced strong exogenous equity flows by index funds. Our event study reveals that countries with a relatively increasing equity representation experienced a relative currency appreciation upon announcement of the index change. Moreover, stock markets that are upweighted (downweighted) feature a higher (lower) permanent comovement of their currency with the basket of other MSCI currencies. The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.

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Bibliographic Info

Article provided by Society for Financial Studies in its journal The Review of Financial Studies.

Volume (Year): 23 (2010)
Issue (Month): 4 (April)
Pages: 1681-1717

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Handle: RePEc:oup:rfinst:v:23:y:2010:i:4:p:1681-1717

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Cited by:
  1. Francis Breedon & Jagjit S Chadha & Alex Waters, 2012. "The financial market impact of UK quantitative easing," BIS Papers chapters, in: Bank for International Settlements (ed.), Threat of fiscal dominance?, volume 65, pages 277-304 Bank for International Settlements.
  2. Bank for International Settlements, 2012. "Threat of fiscal dominance?," BIS Papers, Bank for International Settlements, number 65, 8.
  3. Itzhak Ben-David & Francesco Franzoni & Rabih Moussawi, 2014. "Do ETFs Increase Volatility?," NBER Working Papers 20071, National Bureau of Economic Research, Inc.
  4. Francis Breedon & Angelo Ranaldo, 2013. "Intraday Patterns in FX Returns and Order Flow," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(5), pages 953-965, 08.
  5. Raddatz, Claudio & Schmukler, Sergio L. & Williams, Tomas, 2014. "International asset allocations and capital flows : the benchmark effect," Policy Research Working Paper Series 6866, The World Bank.
  6. Atanasov, Vladimir & Merrick, John, 2011. "Financial asset demand is elastic: Evidence from new issues of Federal Home Loan Bank debt," Journal of Banking & Finance, Elsevier, vol. 35(12), pages 3225-3239.
  7. Hau, Harald, 2009. "The Exchange Rate Effect of Multi-Currency Risk Arbitrage," CEPR Discussion Papers 7348, C.E.P.R. Discussion Papers.

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