Global Portfolio Rebalancing and Exchange Rates
We examine international equity allocations at the fund level and show how different returns on the foreign and domestic proportion of portfolios determine rebalancing behavior and trigger capital flows. We document the heterogeneity of rebalancing across fund types, its greater intensity under higher exchange rate volatility, and the exchange rate effect of such rebalancing. The observed dynamics of equity returns, exchange rates, and fund-level capital flows are compatible with a model of incomplete FX risk trading in which exchange rate risk partially segments international equity markets.
We thank seminar participants in numerous universities for their comments. We are grateful to Paolo Surico for providing his software to calculate quantile range statistics. This research project benefitted from a grant from the Swiss National Science Foundation (SNSF). Hélène Rey is grateful to the ERC for financial support (grant 210584). This research project benefitted from the grants UID/GES/00407/2013 and PTDC/IIM-FIN/2977/2014 from the Portuguese Foundation for Science and Technology-FCT. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.