The geography of international portfolio flows, international CAPM and the role of monetary policy frameworks

Using bilateral data on international equity and bond flows, we find that the prediction of the International Capital Asset Pricing Model is partially met and that global equity markets might be more integrated than global bond markets. Moreover, over the turbulent 1998-2001 period characterised by an equity bubble and the subsequent burst, we find evidence that investors preferred portfolio assets of countries where the central bank gave relative importance to money. As for EMU, once controlling for diversification benefits and the elimination of the exchange rate risk, we show that cross-border portfolio flows among euro area countries have increased due to the catalyst effect of EMU. Country's shares in the world market portfolio, home bias, initial degree of misallocation across countries, past returns, diversification benefits and EMU can explain 35-40% of the total variation in equity and bond asset flows. JEL Classification: C13, C21, F37, G11Capital flows, EMU, home bias, monetary policy, Risk diversification

Trade intensity and output synchronisation: On the endogeneity properties of the EMU

Using annual bilateral data over the period 1988-2011 for a panel of 24 industrialised and emerging economies, we analyse in a time-varying framework the determinants of output synchronisation in EMU (European Monetary Union) distinguishing between core and peripheral member states. The results support the specialisation paradigm rather than the endogeneity hypothesis. Evidence is found in the euro period of diverging patterns between the core and the peripheral EMU countries raising questions about the future stability of EMU

Do international portfolio investors follow firms’ foreign investment decisions?

We analyze the interlinkages between foreign direct investment (FDI) and foreign portfolio investment (FPI) between Germany and the major economies. First, we show that Tobin’s q helps explaining the variation of the growth rate of the stock of FDI. Second, we show that foreign and the home stock market returns explain the ariation of the growth rate of the stock of FPI. Most importantly, we find that information about foreign fundamentals is revealed via direct investment. In other words, FDI transactions measured by fitted growth rates of the stock of FDI help explaining current growth rates of the stock of FPI. To our knowledge this observation is the first unambiguous evidence that international portfolio investors follow firms’ expected foreign investment decisions. JEL Classification: F21, F23, G11, G15and Information Spillovers, Foreign Direct Investment, Foreign Portfolio Investment, Investor Heterogeneity, Tobin’s q

Assessing the benefits of international portfolio diversification in bonds and stocks.

This paper considers a stylized asset pricing model where the returns from exchange rates, stocks and bonds are linked by basic risk-arbitrage relationships. Employing GMM estimation and monthly data for 18 economies and the US (treated as the domestic country), we identify through a simple test the countries whose assets strongly comove with US assets and the countries whose assets might other larger diversification benefits. We also show that the strengthening of the comovement of returns across countries is neither a gradual process nor a global phenomenon, reinforcing the case for international diversification. However, our results suggest that fund managers are better other constructing portfolios selecting assets from a subset of countries than relying on either fully inter-nationally diversified or purely domestic portfolios. JEL Classification: F31, G10asset pricing, Exchange Rates, international parity conditions, market integration, stochastic discount factor

Explaining exchange rate dynamics: the uncovered equity return parity condition

By employing Lucas’ (1982) model, this study proposes an arbitrage relationship – the Uncovered Equity Return Parity (URP) condition – to explain the dynamics of exchange rates. When expected equity returns in a country/region are lower than expected equity returns in another country/region, the currency associated with the market offering lower returns is expected to appreciate. First, we test the URP assuming that investors are risk neutral and next we relax this hypothesis. The resulting risk premia are proxied by economic variables, which are related to the business cycle. We employ differentials in corporate earnings’ growth rates, short-term interest rate changes, annual inflation rates, and net equity flows. The URP explains a large fraction of the variability of some European currencies vis-à-vis the US dollar. When confronted with the naïve random walk model, the URP for the EUR/USD performs better in terms of forecasts for a set of alternative statistics. JEL Classification: D82, G14, G15asset pricing, foreign exchange markets, GMM, random walk, UIP

Financial integration, international portfolio choice and the European Monetary Union

We investigate the determinants of bilateral international equity and bond portfolio reallocation across a large cross section of countries over the 1997 to 2001 period. We first argue that financial integration is not a global phenomenon, as equity and bond home biases declined significantly only among European countries, Australia, New Zealand and Singapore. Then, we show that the European Economic and Monetary Union (EMU) eased the access to the equity market and, to a larger extent, the bond market; thereby, enhancing regional financial integration in the euro area. Beside the effect of the EMU, the strongest determinants of the changes in portfolio weights are expected diversification benefits and the initial degree of underweight. JEL Classification: C13, C21, F37, G11EMU, home bias, International portfolio weights, Risk diversification

Foreign direct investment and environmental taxes

This paper studies the effect of foreign direct investment (FDI) on environmental policy stringency in a two-country model with trade costs, where FDI could be unilateral and bilateral and both governments address local pollution through environmental taxes. We show that FDI does not give rise to ecological dumping because the host country has an incentive to shift rents away from the source country towards the host country. Environmental policy strategies and welfare effects are studied under the assumption that parameter values support FDI to be profitable. JEL Classification: F12, F18, F23environmental taxes, Foreign Direct Investment, multinational enterprises, plant location

On the determinants of external imbalances and net international portfolio flows: a global perspective

In a panel covering a large number of countries from 1970 to 2003, we show that net portfolio flows play an important role in correcting external imbalances, since they are driven by common determinants represented by countries’ demographic profiles, the quality of institutions, monetary aggregates and initial net financial asset positions. Population ageing causes current account deficits, net equity inflows and net outflows in debt instruments. A higher money to GDP ratio – associated with lower interest rates – favours international investments in domestic stocks to the detriment of the less attractive domestic bonds. Additionally, current account balances are driven negatively by real GDP growth, losses in competitiveness and increases in the quality of the institutions; net equity flows are driven positively by the quality of the institutions and negatively by per capita income; while net flows in debt instruments are driven by long-term interest rate differentials and deviations from the UIP. JEL Classification: F21, F32, F41, O16Current accounts, net portfolio flows, panel regressions