International asset allocations and capital flows: The benchmark effect

Abstract

Benchmark indexes have become important in financial markets for portfolio investment. In this paper, we study how international equity and bond market indexes impact asset allocations, capital flows, asset prices, and exchange rates across countries. We use unique monthly microlevel data of benchmark compositions and mutual fund investments during 1996-2014. We find that movements in benchmarks appear to have important effects on equity and bond mutual fund portfolio allocations, including passive and active funds. The effects persist after controlling for time-varying industry-level factors, country-specific effects, and macroeconomic fundamentals. Changes in benchmarks not only impact asset allocations, but also capital flows, abnormal returns in aggregate stock and bond prices, and exchange rates. These systemic effects occur not just when the benchmark changes are announced, but also later, when they become effective. By impacting country allocations, benchmarks explain apparently counterintuitive movements in capital flows and asset prices, as well as contagion effects.

Search for Yield in Large International Corporate Bonds: Investor Behavior and Firm Responses

“…6 Our paper extends to the global sphere the evidence that an increase in demand from passive investors increases firms' propensity to issue bonds in the United States (Dathan and Davydenko, 2018). 7 Second, we contribute to a growing literature studying how the low interest rate environment after the GFC encouraged dollar-denominated corporate bond issuance 5 See, among others, Harris and Gurel (1986), Shleifer (1986), Chen et al (2004), Barberis et al (2005), Greenwood (2005), Hau et al (2010), Claessens and Yafeh (2013), Chang et al (2015), Raddatz et al (2017), and Pandolfi and Williams (2019). 6 The magnitude of our estimates of the reduction in yields of index-eligible bonds is within the same range of the model-implied estimates provided by Kashyap et al (2018).…”

“…See Cremers and Petajisto (2009) for evidence on the U.S. equity mutual fund industry. Cremers et al (2016) and Raddatz et al (2017) show this pattern at the international level. An extreme instance of this strategy is that used by exchange-traded funds (ETFs), the importance of which has increased (Converse et al, 2018). are included in market indexes are bought and sold more frequently and are held by a wide range of investors, which means that holding a bond that is included in the index enhances its liquidity.…”

Search for Yield in Large International Corporate Bonds: Investor Behavior and Firm Responses

“…See Cremers and Petajisto (2009) for evidence on the U.S. equity mutual fund industry. Cremers et al (2016) and Raddatz et al (2017) show this pattern at the international level. An extreme instance of this strategy is that used by exchange-traded funds (ETFs), the importance of which has increased (Converse et al, 2018).…”

Financial globalization: A glass half empty?

“…In contrast, countries that have performed poorly in the past will have a lower relevance in the index and, thus, suffer lower withdrawals during crises (Raddatz et al, 2017).…”