nep-ifn New Economics Papers
on International Finance
Issue of 2017‒10‒08
two papers chosen by
Vimal Balasubramaniam
University of Oxford

  1. International Asset Allocations and Capital Flows: The Benchmark Effect By Claudio Raddatz; Sergio Luis Schmukler; Tomas Williams
  2. Why Are Exchange Rates So Smooth? A Household Finance Explanation By YiLi Chien; Hanno Lustig; Kanda Naknoi

  1. By: Claudio Raddatz; Sergio Luis Schmukler (World Bank 1818 H Street NW, MC 3-301 Washington, DC 20433); Tomas Williams
    Abstract: We study different channels through which well-known benchmark indexes impact asset allocations, capital flows, asset prices, and exchange rates across countries, using unique monthly micro-level data of benchmark compositions and mutual fund investments during 1996-2014. We exploit different events and the presence of countries in multiple benchmarks to study the impact of benchmarks. We find that movements in benchmarks appear to have important effects on equity and bond mutual fund portfolios, including passive and active funds. The effects persist even after controlling for other relevant variables, such as time-varying industry-level factors, country-specific effects, and macroeconomic fundamentals. Exogenous, pre-announced changes in benchmarks impact asset allocations, capital flows, and abnormal returns in asset prices and exchange rates. These systemic effects occur not just when the benchmark changes are announced, but also later on when they become effective. By impacting country allocations, benchmarks explain apparently counterintuitive movements in capital flows and aggregate prices.
    Keywords: benchmark indexes, contagion, coordination mechanism, ETFs, international asset prices, international portfolio flows, mutual funds
    JEL: F32 F36 G11 G15 G23
    Date: 2017–09
  2. By: YiLi Chien (Federal Reserve Bank of St. Louis); Hanno Lustig (Stanford Graduate School of Business); Kanda Naknoi (University of Connecticut)
    Abstract: Empirical moments of asset prices and exchange rates imply that pricing kernels have to be almost perfectly correlated across countries. If they are not, observed real exchange rates are too smooth to be consistent with high Sharpe ratios in asset markets. However, the cross-country correlation of macro fundamentals is far from perfect. We reconcile these empirical facts in a two-country stochastic growth model with heterogeneous trading technologies for households and a home bias in consumption. In our model, only a small fraction of households actively participate in international risk sharing by frequently trading domestic and foreign equities. These active traders, who induce high cross-country correlation to the pricing kernels, are the marginal investors in foreign exchange markets. In a calibrated version of our model, we show that this mechanism can quantitatively account for the excess smoothness of exchange rates in the presence of highly volatile pricing kernels and weakly correlated macro fundamentals.
    Keywords: asset pricing, market segmentation, exchange rate, international risk sharing
    JEL: G15 G12 F31 F10
    Date: 2017–09

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