Exchange rate uncertainty and international portfolio flows: A multivariate GARCH-in-mean approach

Abstract

This paper examines the impact of exchange rate uncertainty on different components of net portfolio flows, namely net equity and net bond flows, as well as their dynamic linkages. Specifically, a bivariate VAR GARCH-BEKK-in-mean model is estimated using bilateral monthly data for the US vis-à-vis Australia, Canada, the euro area, Japan, Sweden, and the UK over the period 1988:01-2011:12. The results indicate that the effect of exchange rate uncertainty on net equity flows is negative in the euro area, the UK and Sweden, and positive in Australia. The impact on net bond flows is also negative in all countries except Canada, where it is positive.Under the assumption of risk aversion, the findings suggest that exchange rate uncertainty induces a home bias and causes investors to reduce their financial activities to maximise returns and minimise exposure to uncertainty, this effect being stronger in the UK, the euro area and Sweden compared to Canada, Australia and Japan. Overall, the results indicate that exchange rate or credit controls on these flows can be used as a policy tool in countries with strong uncertainty effects to pursue economic and financial stability. AbstractThis paper examines the impact of exchange rate uncertainty on different components of net portfolio flows, namely net equity and net bond flows, as well as their dynamic linkages. Specifically, a bivariate VAR GARCH-BEKK-in-mean model is estimated using bilateral monthly data for the US vis-à-vis Australia, Canada, the euro area, Japan, Sweden, and the UK over the period 1988:01-2011:12. The results indicate that the effect of exchange rate uncertainty on net equity flows is negative in the euro area, the UK and Sweden, and positive in Australia. The impact on net bond flows is also negative in all countries except Canada, where it is positive.Under the assumption of risk aversion, the findings suggest that exchange rate uncertainty induces a home bias and causes investors to reduce their financial activities to maximise returns and minimise exposure to uncertainty, this effect being stronger in the UK, the euro area and Sweden compared to Canada, Australia and Japan. Overall, the results indicate that exchange rate or credit controls on these flows can be used as a policy tool in countries with strong uncertainty effects to pursue economic and financial stability.

Effect of Exchange Rate Returns on Equity Prices: Evidence from South Africa and Nigeria

“…The paper concludes that policies aimed at diversifying the Nigerian economy, encouraing more non-oil stocks to be quoted in the Nigerian stock exchange, while keeping watch on all forms of insider abuse with regards to oil stocks, will be critical to enhance the performance of the Nigerian stock exchange. The significance of exhange rate returns in the Nigerian stock exchange and the need to curtail its effect on the Nigerian stock exchange, is consistent with Caporale et al (2015) who argued that exchange rate or credit controls can be used to improve the flow of investment particularly in countries where high level of uncertainty affects economic and financial system stability. Considering the rapid drop in the Nigerian naira in recent times and the results obtained from this study, the intervention of the CBN which intervenes in the nation's forex through the supply side is justified.…”

“…Papaioannou, 2006;Agrawal et al, 2010;Mlambo et al, 2013;Caporale et al, 2015;Abraham, 2016;Sichoongwe, 2016;Ozhan et al, 2016;Sichoongwe, 2016;Gatawa & Mahmud, 2017;and Gatawa & Mahmud, 2017). However, little information is available from these studies on the effect of exchange rate returns and its volatility on the stock market.…”

“…Using a multivariate GARCH in-mean approach, Caporale, Ali, and Spagnolo (2015) examined the effect of exchange rate uncertainty and international portfolio flows for the euro area, Japan, Sweden and the UK from 1988 to 2011. Their finding revealed that exchange rate uncertainty induces a home bias and causes investors to reduce their financial activities in order to maximize returns and minimize exposure to uncertainty.…”

Capital flows and GDP in emerging economies and the role of global spillovers

“…Some studies indeed have provided evidence for forecasting power of net foreign asset positions and capital flows on bilateral exchange rates (Della Corte et al, 2012). Another strand of the literature considers the opposite causality, for example by analyzing the effect of exchange rate uncertainty on different components of net portfolio flows (Caporale et al, 2015). A distinction of FDI and portfolio flows is necessary in the context of uncertainty and volatility (Pagliari and Hannan, 2017).…”

How Can We Interpret the Estimates of the Full BEKK Model with Asymmetry? The Case of French and German Stock Returns

“…Long et al (2014) analyzed the conditional time-varying currency betas for five developed and six emerging financial markets by using a BEKK model. Employing a BEKK model, Caporale et al (2015) tested the impact of exchange rate uncertainty on net equity and net bond flows and on their dynamic linkages. Using BEKK and dynamic conditional correlation (DCC) models of Engle (2002), Zhou (2016) compared the hedge-ratio estimations for REIT futures.…”