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Emerging market bond flows and exchange rate returns

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  • Peter Hördahl
  • Giorgio Valente

Abstract

We study the relationship between international bond ows and exchange rate returns for a panel of emerging market economies (EMEs). Specifically, we investigate whether international net bond ows are correlated with subsequent changes in the value of the local currency against the US dollar. Using a portfolio approach, we find evidence of a positive relationship between bond ows and future exchange rate returns of EMEs, which is not present for advanced economy currencies. EME currencies tend to depreciate following large bond out ows, while they tend to appreciate following in ows. A dollar-neutral portfolio that goes long in in ow currencies and shorts out ow currencies earns large excess returns that are not correlated with ones from known international portfolio strategies. Moreover, using an asset pricing approach, we find strong evidence that a risk factor implied by this result is priced in the cross-section of currencies. These findings are consistent with investors requiring compensation for the risk that countries experiencing large portfolio in ows today could be facing a future tightening of their aggregate financial conditions.

Suggested Citation

  • Peter Hördahl & Giorgio Valente, 2022. "Emerging market bond flows and exchange rate returns," BIS Working Papers 1042, Bank for International Settlements.
    • Handle: RePEc:bis:biswps:1042
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    References listed on IDEAS

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    1. Ingomar Krohn & Vladyslav Sushko & Witit Synsatayakul, 2023. "Foreign investor feedback trading in an emerging financial market," BIS Working Papers 1154, Bank for International Settlements.

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    More about this item

    Keywords

    Bond ows; exchange rate dynamics; financial conditions.;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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