Global Portfolio Rebalancing and Exchange Rates

SFI Working Paper No. 18-03, NBER Working Paper No. 24320
with Nelson Camanho and Helene Rey


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.

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