Foreign portfolio investment and the US macroeconomic conditions

Abstract

This paper examines how foreign portfolio investment (FPI) in the US and its components affect the US macroeconomic conditions. We estimate a Dynamic Factor Model to extract comovements from 31 indicators to obtain three composite measures of the US macroeconomic conditions, which correspond to real economic activity, monetary policy, and aggregate uncertainty. We find that an unexpected rise in FPI reduces long-term interest rates, raises real output production and employment, and lowers aggregate risks. Our results also show that the equity portion of FPI is significantly more sensitive to shocks to domestic market conditions than the debt portion of FPI. However, both components contribute substantially to the fluctuations of the US macroeconomic conditions. Finally, we find that shocks to FPI are one of the most significant contributors to the historical fluctuations in all output, monetary, and risk conditions. In particular, the equity component contributes substantially during economic recessions, while the debt component is the dominant force during economic booms.