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

Guglielmo Maria Caporale, Faek Menla Ali and Nicola Spagnolo

Journal of International Money and Finance, 2015, vol. 54, issue C, 70-92

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.

Keywords: Exchange rate uncertainty; Equity flows; Bond flows; Causality-in-variance (search for similar items in EconPapers)
JEL-codes: F31 F32 G15 (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (46)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:54:y:2015:i:c:p:70-92

DOI: 10.1016/j.jimonfin.2015.02.020

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