NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

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

Harald Hau, Helene Rey

NBER Working Paper No. 10476
Issued in May 2004
NBER Program(s):   IFM   AP

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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Document Object Identifier (DOI): 10.3386/w10476

Published: 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.

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