Portfolio rebalancing in times of stress

Andreas M. Fischer, Rafael Greminger and Dr. Christian Grisse



JEL classification
F30, G11, G15

Portfolio rebalancing, equity flows, exchange rates, financial stress, structural VAR, sign restrictions, regime switching


This paper investigates time variation in the dynamics of international portfolio equity flows. We extend the empirical model of Hau and Rey (2004) by embedding a two-state Markov regime-switching model into the structural VAR. The model is estimated using monthly data for the period 1995-2015 on equity returns, exchange rate returns and equity flows between the United States and advanced and emerging economies. We find that the data are consistent with portfolio rebalancing. The estimated states match periods of low and high financial stress. Our main result is that for equity flows between the United States and emerging markets, the rebalancing dynamics differ between high and low episodes of financial stress. A switch from the low to the high stress regime is associated with capital outflows from emerging markets. Once in the high stress regime, the response of capital flows to exchange rate shocks is smaller than in normal (low stress) periods.