Global Portfolio Rebalancing under the Microscope

SFI Working Paper No. 17-xx
with Nelson Camanho and Helene Rey

Abstract

Cross border capital flows and returns on assets are two key variables in international macroeconomics. Difficult endogeneity issues plague any analysis of their correlations in aggregate data. In this paper we examine the international equity allocations at the fund level and show how differential returns on the foreign and domestic proportion of their portfolios determine the rebalancing behavior and capital flows. The observed dynamics of equity returns, exchange rates and fund-level capital flows is compatible with a model of incomplete FX risk trading in which exchange rate risk partially segments international equity markets.

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