Equity flows, stock returns and exchange rates

We explore the effects of equity flows between U.S. and U.K. investors upon equity and exchange rate returns within a unified empirical framework on the basis of a trivariate vector autoregressive system that incorporates mean and volatility spillovers and allows for dynamic conditional correlations. Our findings are as follows: First, we reveal strong evidence of volatility spillovers across equity returns, exchange rate returns, and equity flows. Second, we find strong evidence that U.K. investors rebalance their portfolios by engaging in a positive feedback trading known in the literature as “trend chasing.” Third, we document strong dynamic effects from net flows to equity returns, illustrating a trading rule that portfolios are dynamically adjusted over a short‐run horizon influencing changes in stock returns. Last, correlation uncertainty appears to be reduced from the start of the 1990s onwards.