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Can Portfolio Rebalancing Explain the Dynamics of Equity Returns, Equity Flows, and Exchange Rates?

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  • Harald Hau
  • Helene Rey

Abstract

We explore whether the pattern of international equity returns, equity portfolio flows, and exchange rate returns are consistent with the hypothesis that (unhedged) global investors rebalance their portfolio in order to limit their exchange rate exposure when there are (1) relative equity return and (2) exchange rate shocks. We also explore whether (3) equity flow shocks influence the exchange rates and relative equity prices. In the estimation of the VAR system we do not impose any causal ordering upon the primitive shocks, but instead identify the system based on theoretical priors about the contemporaneous conditional correlations between the three variables. International data for the five largest equity markets are consistent with a theory in which equity returns and portfolio rebalancing are an important source of exchange rate dynamics.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10476.

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Date of creation: May 2004
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Publication status: published as Hau, Harald and Helene Rey. "Can Portfolio Rebalancing Explain The Dynamics Of Equity Returns, Equity Flows, And Exchange Rates?," American Economic Review, 2004, v94(2,May), 126-133.
Handle: RePEc:nbr:nberwo:10476

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  1. Killeen, William P. & Lyons, Richard K. & Moore, Michael J., 2006. "Fixed versus flexible: Lessons from EMS order flow," Journal of International Money and Finance, Elsevier, vol. 25(4), pages 551-579, June.
  2. Harald Hau & Hélène Rey, 2006. "Exchange Rates, Equity Prices, and Capital Flows," Review of Financial Studies, Society for Financial Studies, vol. 19(1), pages 273-317.
  3. Anna Pavlova & Roberto Rigobon, 2003. "Asset Prices and Exchange Rates," NBER Working Papers 9834, National Bureau of Economic Research, Inc.
  4. Uhlig, Harald, 2005. "What are the effects of monetary policy on output? Results from an agnostic identification procedure," Journal of Monetary Economics, Elsevier, vol. 52(2), pages 381-419, March.
  5. Fabio Canova & Gianni De Nicolo, 2000. "Monetary disturbances matter for business fluctuations in the G-7," International Finance Discussion Papers 660, Board of Governors of the Federal Reserve System (U.S.).
  6. Martin D.D. Evans & Richard K. Lyons, 2004. "A New Micro Model of Exchange Rate Dynamics," NBER Working Papers 10379, National Bureau of Economic Research, Inc.
  7. Martin D.D. Evans & Richard K. Lyons, 1999. "Order Flow and Exchange Rate Dynamics," NBER Working Papers 7317, National Bureau of Economic Research, Inc.
  8. Harald Hau & William Killeen & Michael Moore, 2002. "How has the euro changed the foreign exchange market?," Economic Policy, CEPR & CES & MSH, vol. 17(34), pages 149-192, 04.
  9. Branson, William H. & Henderson, Dale W., 1985. "The specification and influence of asset markets," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 15, pages 749-805 Elsevier.
  10. Kenneth A. Froot & Tarun Ramadorai, 2002. "Currency Returns, Institutional Investor Flows, and Exchange Rate Fundamentals," NBER Working Papers 9080, National Bureau of Economic Research, Inc.
  11. Evans, Martin D.D. & Lyons, Richard K., 2008. "How is macro news transmitted to exchange rates?," Journal of Financial Economics, Elsevier, vol. 88(1), pages 26-50, April.
  12. Richard K. Lyons, 2006. "The Microstructure Approach to Exchange Rates," MIT Press Books, The MIT Press, edition 1, volume 1, number 026262205x, December.
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