Abstract
Employing monthly data for 53 countries between 1996 and 2015, we investigate the relationship between international fund flows and exchange rate dynamics. We find strong co-movement between funds flows (as measured with the EPFR Global data base) and bilateral real exchange rates vis-à-vis the USD. This holds both for equity flows and bond flows. However, bond flows have a more significant relationship with RER appreciation than equity flows in developing countries, while in developed countries equity flows play a more important role. Under a more flexible exchange rate regime the real exchange rate appreciation associated with fund flows is higher.
Highlights
Explaining exchange rate dynamics has been an important issue in international finance since the breakdown of the Bretton Woods System (De Grauwe and Dewachter 1993; Williamson 2009; An and Wang 2012; Balke et al 2013; Tang and Zhou 2013)
The results of Jongwanich and Kohpaiboon (2013) suggest that an increase in portfolio capital flows and bank loans quickly results in a real exchange rate appreciation, while the effect of FDI occurs with a lag
Splitting the sample in developed and developing countries, we find that the coefficient on bond flows is more significant than that on equity flows in developing countries, while in developed countries equity flows play a more important role
Summary
Explaining exchange rate dynamics has been an important issue in international finance since the breakdown of the Bretton Woods System (De Grauwe and Dewachter 1993; Williamson 2009; An and Wang 2012; Balke et al 2013; Tang and Zhou 2013). This paper investigates the relationship between one type of international capital flows, namely international fund flows, and exchange rate dynamics. Existing studies suggest that financial portfolio investments play a more important role in exchange rate dynamics than other types of capital flows such as FDI and bank loans (Combes et al 2012; Jongwanich and Kohpaiboon 2013). The following questions are addressed in this research: (i) What is the relationship between international fund flows and real exchange rate (RER) dynamics?
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