Portfolio Capital Flows and the US Dollar Exchange Rate: Viewed from the Lens of Time and Frequency Dynamics of Connectedness

Using high-frequency, proprietary data on daily net non-resident portfolio flows to emerging markets, our study finds in the time domain connectedness framework that, to varying degrees, there is less interconnectedness in non-resident debt and equity portfolio flows to our sample of emerging market (EM) economies during normal times. In contrast, during times of uncertainty and stress, the interconnectedness of portfolio flows intensifies. This indicates the notion of asymmetry in the spillovers of these portfolio flows during periods of stress relative to normal times. More importantly, over most of the sample period, we find that shocks in the broad EM US dollar exchange rate can have important effects on these interconnections where, based on estimates of the net directional spillover index, the broad EM US dollar exchange rate is a net transmitter of shocks to debt and equity portfolio flows of the EM economies. Using the more recent frequency domain approach to connectedness, we find that the broad EM US dollar exchange rate is a net transmitter of shocks to the EM economies’ debt and equity flows with the impact of such shocks hitting portfolio capital flows within at least a week to 100 days. In addition to the importance of pre-emptive prudential policy levers, efforts toward better monitoring of risks can contribute to creditors and investors in EM economies becoming more resilient to global shocks, particularly, during times of US dollar appreciations when these portfolio flows tend to reverse.