Real financial market exchange rate volatility and portfolio flows
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This paper studies the relationship between real financial market exchange rate volatility and US cross-border equity flows. We found strong evidence that causality goes from real financial market exchange rate volatility to equity flows. According to our results, real financial market exchange rate volatility negatively influences purchases of foreign equity. This finding is in line with the portfolio optimization theory. The impact of real financial market exchange rate volatility on sales of foreign equity is also negative. This result can be explained by the theory of behavioral finance which states that investors are reluctant to realize losses of their portfolios. This is why investors decrease sales of assets when riskiness of the assets increases. The impact of real financial market exchange rate on net purchases of foreign equity is positive. It follows from these results that sales of foreign equity decrease more strongly than purchases of foreign equity when riskiness of foreign assets increases.
KeywordsReal financial market exchange rate Volatility Portfolio flows
JEL classificationC33 E52 E58 F42
I would like to thank Stefan Reitz for his valuable comments and suggestions as well as Lucio Sarno for the fruitful discussion on this research. I am grateful to participants of the 2015 Goettingen International Economic Relationships workshop, the May 2015 Economic Faculty Meeting at the University of Warsaw, the conference 2015 Spring Meeting of Young Economists and the 2015 European Economic and Finance Society conference for their comments and suggestions. Valuable suggestions from an anonymous referee of this journal are appreciated.
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