Portfolio Flows, Global Risk Aversion and Asset Prices in Emerging Markets

Abstract

In recent years, portfolio flows to emerging markets (EMs) have become increasingly large and volatile. Using weekly portfolio fund flows data, the paper finds that their short-run dynamics are driven mostly by global "push" factors. To what extent do these cross-border flows and global risk aversion drive asset volatility in EMs? We use a Dynamic Conditional Correlation (DCC) Multivariate GARCH framework to estimate the impact of portfolio flows and the VIX index on three asset prices, namely equity returns, bond yields and exchange rates, in 17 emerging economies. The analysis shows that global risk aversion has a significant impact on the volatility of asset prices, while the magnitude of that impact correlates with country characteristics, including financial openness, the exchange rate regime, as well as macroeconomic fundamentals such as inflation and the current account balance. In line with earlier literature, portfolio flows to EMs are also found to affect the level of asset prices, as was the case in particular during the global financial crisis.

What Drives Capital Flows to Emerging Markets? A Survey of the Empirical Literature

“…For example, Fratzscher () and Koepke () find only a limited role for domestic macroeconomic variables at the weekly and monthly frequencies, respectively, while Baek () and De Vita and Kyaw () find strong evidence for the role of domestic output growth at the quarterly frequency. These results are consistent with Ananchotikul and Zhang (), who use weekly fund flows data and find that the contributions from external factors are much more volatile, while those of pull factors are small at high frequencies but more persistent. A promising avenue for future research would be to compare push and pull drivers systematically using a common methodological approach across different frequencies for the various capital flows components.…”

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

“…A consequent causality analysis of capital flow impacts on GDP which also addresses international spillovers in a fully endogenous and time-varying framework still presents a gap in the literature. This is of particular relevance for emerging markets where short-run portfolio flows are driven by global 'push' factors to a large extent (Ananchotikul and Zhang, 2014). While early work prior to the currency crises in the nineties has argued that country-specific factors are more important compared to global factors (Chuhan et al, 1998), subsequent studies (Kim, 2000) have identified external global factors such as production or interest rate shocks as the main drives of capital flows to developing and emerging markets such as Asia or South America.…”

“…The amplified impact of portfolio flows on asset price volatility in emerging markets during the crisis (Ananchotikul and Zhang, 2014) does not seem to transmit into negative GDP effects over the full sample period.…”

Institutional investors’ allocation to emerging markets: A panel approach to asset demand

“…In the literature one can finds examples where the VIX index is regressed with stationary variables in levels (Ahmed and Zlate, 2013;Ananchotikul and Zhang, 2014). In fact, when the test is done considering a longer time-series, the tests seem to reject the null of unit root 14 .…”

“…2 cyclical nature of financial cycles (Ananchotikul and Zhang, 2014;Ahmed and Zlate, 2013;Bruno and Shin, 2013a,b;Rey, 2013).…”