Global portfolio investments and FX derivatives

Tsvetelina Nenova, Andreas Schrimpf and Hyun Song Shin

No 1273, BIS Working Papers from Bank for International Settlements

Abstract: We show that outstanding volumes in FX swaps serve as a good indicator for the hedging activity associated with portfolio positions of advanced economy bond investors. As such, FX swaps serve as a key barometer of risk-taking and global financial conditions. We develop a simple portfolio choice model for international bond investors and use it to estimate the relationship between global FX hedging activity, relative investment opportunities (captured by the yield curve slopes in respective economies), and the hedging costs associated with underlying investments. We find that higher FX hedging activity is closely associated with US portfolio debt inflows and outflows, indicating that FX hedging plays a crucial role in facilitating cross-border bond investments. This connection between FX hedging motives, portfolio bond flows, and the yield curve highlights a mechanism of international financial spillovers - not only from the US but also from advanced economies with significant accumulated wealth flowing into the US.

Keywords: global portfolio investments; FX hedging; financial conditions (search for similar items in EconPapers)
JEL-codes: F31 F32 F42 G15 (search for similar items in EconPapers)
Date: 2025-06
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