Portfolio capital flows and the US dollar exchange rate: Viewed from the lens of time and frequency dynamics of connectedness

This study uses proprietary data on daily net non-resident portfolio flows to emerging markets to analyse the interconnectedness of non-resident debt and equity portfolio flows under different market conditions. We find that there is less interconnectedness during normal times but increased interconnectedness during periods of uncertainty and stress, suggesting an asymmetry in the spillovers of these portfolio flows. Importantly, we find that shocks in the broad EM US dollar exchange rate are a net transmitter of shocks to debt and equity portfolio flows of EM economies. Our analysis, based on the net directional spillover index, shows that this effect is most pronounced during the COVID-19 pandemic. Furthermore, using a frequency domain approach to connectedness, we find that the broad EM US dollar exchange rate is a net transmitter of shocks to the EM economies’ debt and equity flows, with the impact hitting portfolio capital flows within at least a week to 100 days. Our results suggest that pre-emptive macroprudential policy measures and better risk monitoring can improve the resilience of borrowers and investors in EM economies during times of global shocks, particularly during US dollar appreciations when portfolio flows tend to reverse.     

Evaluating corporate credit risks in emerging markets

Corporate leverage among emerging market firms went up considerably after the 2007–09 Global Financial Crisis (GFC). We investigate how the increased emerging market corporate leverage in the post-GFC period (2010–15) impacted the underlying credit risk, compared to the pre-GFC (2002–2006) and GFC (2007–09) periods. Using firm-level credit risk, financial, and balance sheet data for 350 firms in 23 emerging markets, we find that leverage growth leads to a significant increase in corporate credit default swap (CDS) spreads only in the post-GFC period, and the incremental effect is mainly evident among risky firms (firms with high leverage and idiosyncratic volatility). In contrast, emerging market CDS spreads during the GFC period are mainly driven by global market risk factors. The post-GFC corporate debt vulnerability is mitigated for high growth prospect firms and firms domiciled in countries with high net capital inflows and superior governance. While corporate leverage growth impacts aggregate corporate credit risk, there is no evidence that it increases sovereign credit risk. Our paper contributes to the recent literature on potential sources of default risk in emerging markets.     

Portfolio and welfare consequences of debt market dominance

The ability to issue debt that pays in units of the domestic good leads a country to accumulate a large and negative net foreign asset position while maintaining a positive position in equity. This debt market advantage also helps to explain the weak relationship between the real exchange rate and relative consumption. Our stylized model matches the key facts about the U.S. international portfolio, the U.S. real exchange rate, and explains nearly 50% of the observed variation in the valuation effects. We find that taxing bond market transactions increases the volatility of the exchange rate, capital flows and allocations. In contrast, taxing equity positions stabilizes the exchange rate and capital flows while having little impact on the allocation. Lastly, the paper describes a global solution method for portfolio problems under incomplete markets.     

Cross-hedging strategies between CDS spreads and option volatility during crises

This paper presents a joint analysis of the term structure of credit default swap (CDS) spreads and the implied volatility surface for five European countries from 2007 to 2012, a sample period covering both the Global Financial Crisis (GFC) and the European debt crisis. We analyze to which extent effective cross-hedges can be performed between the credit and equity derivatives markets during these two crises. We find that during a global crisis a breakdown of the relationship between credit risk and equity volatility may occur, jeopardizing any cross-hedging strategy, which happened during the GFC. This stands in sharp contrast to the more localized European debt crisis, during which this fundamental relationship was preserved despite turbulent market conditions for both the CDS and volatility markets.     

Linkages between Indian and US financial markets: impact of global financial crisis and Eurozone debt crisis

This paper examines inter-linkages between Indian and US equity, foreign exchange and money markets using the vector autoregressive-multivariate GARCH-BEKK framework. We investigate the impact of global financial crisis (GFC) and Eurozone debt crisis (EZDC) on the conditional volatility and conditional correlation estimates derived from the multivariate GARCH model for Indian and US financial markets. Our results indicate that there is significant bidirectional causality-in-mean between the Indian stock market returns and the Rs./USD market returns, and significant unidirectional causality-in-mean from the US stock market returns to the Indian stock market returns. As regards volatility spillovers, we find that volatility in the Indian stock market rises in response to domestic as well as US financial market shocks but Indian financial market shocks do not impact the US markets. Further, impact of the recent crisis episodes on the covariance matrix is found to be significant. We find that volatility in the Indian and US financial markets significantly amplified during GFC. The conditional correlations across asset markets were significantly accentuated in the wake of the two crisis episodes. The impact of GFC on cross-market conditional correlations is higher for majority of the asset market pairs in comparison to the EZDC.     

Flight-to-quality and correlation between currency and stock returns

We document that capital flows in and out of emerging or developed markets are sensitive to global equity market conditions. Capital tends to move out of emerging into developed countries in global down markets, leading to depreciation (appreciation) of emerging (developed) currencies. This generates a positive (negative) correlation between currency and equity in emerging (developed) markets which is amplified by the magnitude of the capital movement. We also verify that hedging currency risks may undo the natural hedge and increase the total return volatility under negative correlation.     

Hot money in disaggregated capital flows

We explore the possible existence and behavior of hot money in six categories of disaggregated bilateral capital flows (equity inflows, equity outflows, bond inflows, bond outflows, banking credit inflows, and banking credit outflows) for 12 emerging markets vis-à-vis the US from 1995 to 2012 and provides several new findings. First, we identify the existence of hot money in all six categories above and conclude that both gross inflows and gross outflows can be the sources of hot money. Second, hot money in equity inflows (outflows) engages in positive (negative) feedback trading regarding local stock market returns. Third, some categories of hot money have a temporary influence on local stock market returns while the others have a permanent influence, supporting the explanations of both price pressures and information advantage. Finally, local stock market returns in half of our sample countries, which have tightened capital controls during the late 2000s global financial crisis (GFC), are more affected by hot money than in the other half. Our findings confirm several popular conjectures of hot money, and endorse the use of capital controls to limit financial vulnerability in the run-up to and during the GFC.     

International Cross‐Listings and Subsequent Security‐Market Choices: Evidence from ADRs

We study the link between the attributes of American depositary receipt (ADR)‐listed firms and their post‐listing security‐market choices. We find that developed market firms are more likely to issue equity and debt than their emerging market counterparts. Furthermore, we find that large firms are more likely to issue debt and less likely to issue equity. When we examine locations where ADR firms raise their capital, we find that firms originating from countries where the protection of minority shareholders is weak are more likely to issue debt on their home markets and less likely to issue debt on international markets (excluding U.S. markets). Furthermore, ADR firms originating from developed (emerging market) countries are more (less) likely to issue their equity on their domestic markets and less (more) likely to issue equity on international markets (excluding U.S. markets).     

全球投资者国别风险情绪对跨境股票资本流动的影响

本文分析了全球投资者国别风险情绪对跨境股票资本流动的影响,通过构造一般均衡跨期选择模型,刻画了投资者国别风险情绪负向影响跨境股票净资本流入的理论机理以及投资者风险厌恶程度的调节作用,并基于EPFR全球股票型基金微观数据和由大数据文本分析技术构造的全球投资者国别层面风险情绪指标进行实证检验。结果表明:第一,全球投资者对一国的国别风险情绪上升会推升该国的整体风险溢价水平,降低跨境股票型基金净资本流入,尤其是风险厌恶度较高的被动型、开放式和ETF基金;第二,一国金融市场成熟度上升和汇率弹性增强可以缓解全球投资者国别风险情绪对跨境股票型基金净资本流入的负向影响;第三,在全球风险情绪极端低或者各国股票型基金净资本流入极端高的时期,全球投资者国别风险情绪的影响更为显著。     

EMERGING EQUITY MARKETS: ARE THEY FOR REAL?

Using the methodology developed by Fama (1990) and Schwert (1990) , we measure the degree to which six of the largest emerging equity markets in Latin America and Asia are rational in the sense that they incorporate domestic and global shocks to future expected cash flows and time variation in the discount rates that price these flows. The Chilean, Mexican, and, to a lesser extent, Malaysian markets appear more rational than either the Korean and Taiwanese markets or the base case U.S. and Japanese markets. However, we argue that numerous factors make the methodology unable to rank markets by relative efficiency. We also find evidence of the influence of real global variables on the Taiwanese and Korean markets.     

Global financial shocks and foreign asset repatriation: Do local investors play a stabilizing role?

We study the dynamic response of gross capital flows in emerging market economies to different global financial shocks, using a panel vector-autoregressive (PVAR) approach. Our focus lies primarily on the potentially stabilizing role played by domestic investors in offsetting the response of foreign investors to adverse global shocks. We find that, while foreign investors tend to retrench from emerging markets in response to global risk aversion and monetary policy shocks, foreign asset repatriation by resident investors does not always follow suit. Local investors play a meaningful stabilizing role in the face of global risk aversion shocks, with sizeable asset repatriation largely offsetting the retrenchment of non-residents. In contrast, foreign investor retrenchment in response to global monetary policy shocks is not mirrored by asset repatriation. Finally, we find robust evidence that positive global real shocks tend to have a positive impact on net capital inflows to emerging markets. Our results shed light on the likely impact of the Fed's QE tapering on capital flows to emerging market economies.     

Foreign Speculators and Emerging Equity Markets

We propose a cross-sectional time-series model to assess the impact of market liberalizations in emerging equity markets on the cost of capital, volatility, beta, and correlation with world market returns. Liberalizations are defined by regulatory changes, the introduction of depositary receipts and country funds, and structural breaks in equity capital flows to the emerging markets. We control for other economic events that might confound the impact of foreign speculators on local equity markets. Across a range of specifications, the cost of capital always decreases after a capital market liberalization with the effect varying between 5 and 75 basis points.     

Do different streams of capital flows affect asset prices differently?

This paper explores the impact of six types of gross capital flows (debt, equity, and banking gross inflows and outflows) on two dimensions: (1) extreme episodes of surges, stops, flights, and retrenchments, and (2) the probability of boom-busts in ASEAN-4 asset markets for the period 1993–2018. To this end, we first decompose gross capital inflows and outflows from Balance of Payments 5 and 6 and show that ASEAN-4 is largely dominated by portfolio flows and a relatively small magnitude of banking flows. However, when we link this decomposition to the extreme episodes, our findings show banking flows are volatile enough to cause greater occurrences of flight and retrenchment episodes while volatile debt flows tend to lead to surge and stop episodes. In the second part, we construct asset price index for ASEAN-4 that can detect boom-busts periods with a minimal noise-to-signal ratio eight quarters ahead. We use heteroscedasticity panel probit and ordinal generalized linear models to show that fundamental variables and banking inflows are statistically significant at increasing likelihood of boom-busts in asset markets. These two findings highlight that although largest percentage of capital flows come through debt and equity markets, the banking channel is of paramount importance in causing extreme episodes of flight and retrenchment as well as boom-busts of asset markets.     

Dissecting hedge funds' strategies

This paper dissects the dynamics of the hedge fund industry with four financial markets, including the equity market, commodities, currencies, and debt market by employing a large number of assets from these markets. We employ four main representative hedge fund strategy indices, and a cap-weighted global index to estimate an asymmetric dynamic conditional correlation (ADCC) GJR-GARCH model using daily data from April 2003 to May 2021. We break down the performance, riskiness, investing style, volatility, dynamic correlations, and shock transmissions of each hedge fund strategy thoroughly. Further, the impact of commodity futures basis on hedge funds' return is analyzed. Comparing the dynamic correlations during the 2008 global financial crisis (GFC) with COVID-19 pandemic reveals changing patterns in hedge funds' investing styles. There are strong and pervasive shock spillovers from hedge fund industry to other financial markets, especially to futures commodities. An increase in the futures basis of several commodities drives up hedge funds' performance. While hedge fund industry underperforms compared to equity market and commodities, the risk-reward measures show that hedge funds are superior to other markets, and safer than the bond market.     

全球金融周期与跨境资本流动

本文从全球42个主要的股票市场指数提取全球股票市场因子,作为全球金融周期的代理变量,考察全球金融周期对跨境资本总流入的影响。结果发现:(1)当全球股票市场因子(全球风险规避和不确定性)上升时,跨境资本流入显著下降;(2)一国处于经济繁荣时期,经济增速和利率处于相对较高水平,全球金融周期对资本流入的影响会减弱;(3)一国资本账户开放程度或金融发展水平越高,全球金融周期对资本流入的影响会越强;(4)更具弹性的汇率制度尽管不能完全隔绝全球金融周期的影响,但相比固定汇率制度,可提高一国抵御全球金融周期冲击的能力;(5)美国货币政策冲击是全球金融周期的重要驱动因素,并通过全球金融周期影响跨境资本流动。本文的政策含义在于,一国应夯实经济基本面、采取富有弹性的汇率制度和适当的资本管制措施,以缓解全球金融周期给资本流动带来的冲击。     

Nonfinancial Firms as Cross‐Market Arbitrageurs

I demonstrate that nonfinancial corporations act as cross‐market arbitrageurs in their own securities. Firms use one type of security to replace another in response to shifts in relative valuations, inducing negatively correlated financing flows in different markets. Net equity repurchases and net debt issuance both increase when expected excess returns on debt are particularly low, or when expected excess returns on equity are relatively high. Credit valuations affect equity financing as much as equity valuations do, and vice versa. Cross‐market corporate arbitrage is most prevalent among large, unconstrained firms, and helps account for aggregate financing patterns.     

Bank portfolio exposure to emerging markets and its effects on bank market value

This study estimates a model of banking company equity returns taking into consideration book value and market value measures of their exposure to emerging markets debt. In this estimation, general systematic market factors, such as the rate of return on the S&P500 stock index and yields on a constant maturity 5-year Treasury note, are held constant such that the exposure variables are accounting for effects due to banks’ exposure to emerging market debt. The results, although not uniform among banking companies, support the hypothesis that the extent of exposure to emerging market debt are factored into the valuation of banking company equity contemporaneously. The inclusion of a market value indicator adds to the explanation of equity returns of some banks. It is also clear that knowing the extent of the exposure on a book value basis is important information alone that may allow investors to take account of or evaluate the effects of changes in banking company equity valuation from LDC debt exposures. We also perform an event study for three major debt crises to determine whether the market recognizes the effects of these events on bank valuation. The event study results show that there is little information from identifying the time period of the crises on banking company equity returns. Explanations for this are that the information of these possible crises has been embedded in bank changes in exposure and that the market valuation of the emerging market debt is already accounted for by our model.     

Portfolio Capital Flows in Thailand: A Bayesian Model Averaging Approach

We study the gross and net terms of portfolio capital flows by examining their determinants. Through the application of the Bayesian model averaging method, the determinants are evaluated by a set of models instead of a single specification. Our findings show that the magnitude of both gross equity and gross debt flows are large, relative to their net terms. Equity inflows and outflows are quite symmetric with similar determinants; debt inflows and outflows are less symmetric. The paper provides partial evidence to support the importance of both internal and external factors as determinants of capital flows.     

On cross-border bank credit and the U.S. financial crisis transmission to equity markets

This paper examines the role played by cross-border equity, bond and bank credit flows versus international trade in the transmission of the U.S. financial crisis to equity markets worldwide. We estimate vector autoregressive models with exogenous global factors using monthly data on 36 emerging and developed countries. The results from an eclectic methodology that includes causality tests, generalized impulse responses and forecast error variance decompositions indicate that the crisis is mostly transmitted through bank credit rather than portfolio flows and international trade. The results are robust to altering the exogenous versus endogenous vectors of variables, to measuring equity prices in U.S. dollars or local currency, to averaging the data across countries versus averaging the parameters from individual country estimation, and to redefining the start date of the crisis. The findings endorse the use of banking regulation and capital controls as part of the policy toolkit to limit financial vulnerability.     

Global economic activity as an explicator of emerging market equity returns

This paper evaluates whether global economic activity, measured by the maritime index and commodity index, is a distinct common factor in explaining equity returns in emerging markets. We document two important features of global equity markets that show that emerging market equities are a segregated part of the global stock market. First, our results show that increases in global economic activity are associated with higher emerging market equity returns. Second, companies in developed markets that have a significant exposure in emerging markets have incremental exposure to commodity returns. By allocating more capital to emerging market equities, an investor increases portfolio exposure to changes in global economic activity.