Emerging market bond flows and exchange rate returns

Peter Hördahl and Giorgio Valente

No 1042, BIS Working Papers from Bank for International Settlements

Abstract: We study the relationship between international bond ows and exchange rate returns for a panel of emerging market economies (EMEs). Specifically, we investigate whether international net bond ows are correlated with subsequent changes in the value of the local currency against the US dollar. Using a portfolio approach, we find evidence of a positive relationship between bond ows and future exchange rate returns of EMEs, which is not present for advanced economy currencies. EME currencies tend to depreciate following large bond out ows, while they tend to appreciate following in ows. A dollar-neutral portfolio that goes long in in ow currencies and shorts out ow currencies earns large excess returns that are not correlated with ones from known international portfolio strategies. Moreover, using an asset pricing approach, we find strong evidence that a risk factor implied by this result is priced in the cross-section of currencies. These findings are consistent with investors requiring compensation for the risk that countries experiencing large portfolio in ows today could be facing a future tightening of their aggregate financial conditions.

Keywords: Bond ows; exchange rate dynamics; financial conditions. (search for similar items in EconPapers)
JEL-codes: F31 G12 G23 G24 (search for similar items in EconPapers)
Pages: 41 pages
Date: 2022-09
New Economics Papers: this item is included in nep-ifn and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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