Portfolio rebalancing in times of stress
Andreas M. Fischer, Rafael Greminger and Christian Grisse
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.