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Capital Flows and Exchange Rates An empirical Analysis

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  • Gregorios Siourounis

Abstract

This paper investigates the empirical relationship between capital flows and nominal ex-change rates for five major countries. It is well known that no theory based on current account or interest rates has ever been shown to work empirically at short to medium horizons. Recent international finance theory, however, suggests that currencies are influenced by capital flows as much as by current account balances and log-term interest rates. Using unrestricted VAR's we document the following: a) Incorporating net cross-border equity flows into linear exchange rate models can improve their in-sample performance. Using net cross-border bond flows, however, has no such effect; b) Positive shocks to home equity returns (relative to foreign markets) are associated with short-run home currency appreciation and equity inflow. Positive shocks to home interest rates (relative to foreign countries) cause currency movements that are not consistent with uncovered interest rate parity (UIP); c) An equity-augmented linear model supports exchange rate predictability and outperforms a random walk in several cases. Such superior forecast performance, however, depends on the exchange rate and the forecast horizon.

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File URL: http://econ.uop.gr/~econ/RePEc/pdf/capital_flows_May_2008.pdf
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Bibliographic Info

Paper provided by University of Peloponnese, Department of Economics in its series Working Papers with number 00028.

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Length: 40 pages
Date of creation: 2008
Date of revision:
Handle: RePEc:uop:wpaper:00028

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Keywords: Net equity flows; net bond flows; equity returns; interest rates; and nominal exchange rates.;

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Cited by:
  1. Jacob Gyntelberg & Mico Loretan & Tientip Subhanij & Eric Chan, 2009. "Private information, stock markets, and exchange rates," BIS Working Papers 271, Bank for International Settlements.
  2. Nicolas Coeurdacier & Robert Kollmann & Philippe Martin, 2010. "International portfolios, capital accumulation and foreign assets dynamics," Sciences Po publications info:hdl:2441/c8dmi8nm4pd, Sciences Po.
  3. Papaioannou, Elias & Portes, Richard & Siourounis, Gregorios, 2006. "Optimal currency shares in international reserves: The impact of the euro and the prospects for the dollar," Journal of the Japanese and International Economies, Elsevier, vol. 20(4), pages 508-547, December.
  4. Thomas Nitschka, 2009. "Momentum in stock market returns, risk premia on foreign currencies and international financial integration," IEW - Working Papers 405, Institute for Empirical Research in Economics - University of Zurich.
  5. Maria Gelman & Axel Jochem & Stefan Reitz & Mark P. Taylor, 2014. "Real Financial Market Exchange Rates and Capital Flows," Kiel Working Papers 1945, Kiel Institute for the World Economy.
  6. Wei Sun & Lian An, 2011. "Dynamics of floating exchange rate: how important are capital flows relative to macroeconomic fundamentals?," Journal of Economics and Finance, Springer, vol. 35(4), pages 456-472, October.
  7. Thomas Nitschka, 2007. "Consumption growth, uncovered equity parity and the cross-section of returns on foreign currencies," IEW - Working Papers 340, Institute for Empirical Research in Economics - University of Zurich.

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