Portfolio Balance Model Research Articles

Comparative Analysis of the Portfolio-balance Models of Exchange Rate Determination

The current study conducts a comparative analysis of Portfolio-Balance Models (PBM) developed by Branson, Kouri and Dornbusch to assess the role of expectations and time horizons in determining and forecasting the India–US exchange rate over the period 1996:Q2–2019:Q3. Notably, it improves the original models by integrating microstructure theory into their framework. The Autoregressive Distributed Lag Error-Correction Model (ARDL-ECM) is used to investigate both short run and long run behaviour of the models. Additionally, the study assesses out-of-sample forecasting accuracy of the modified models against the Random Walk Model (RWM) using the root mean square error metric. The estimation results reveal that models based on rational expectations are better than the static expectations model. Notably, the microeconomic determinant is counterintuitively significant only in the long run across all models. Furthermore, these modified models demonstrate superior out-of-sample forecasting abilities compared to RWM for alternative forecasting horizons. However, forecasting results over a 6-month period is better with short run models. Over 1-year and 2-year horizons, rational expectations models outperform the static expectations model. This study challenges the Meese–Rogoff puzzle, ensuring that PBM, when modified to incorporate microstructure theory, is valid and yields superior forecasting results compared to RWM. JEL Codes: F31, F32, C22

Review of Literature on Macroeconomic Determinants of Equity Share Prices

The present study attempts to examine the relationship found in empirical studies of macroeconomic variables namely, exchange rate, money supply, inflation, industrial production, foreign exchange reserves and interest rate with stock market indices in the post-reform era of liberalization. Classical economists argued that the exchange rates lead stock prices with positive correlation whereas the proponents of portfolio-balance model argue that, being part of wealth, equity may affect the exchange rates through demand for money implying that stock prices lead exchange rates with negative correlation. Money supply was found to have negative and positive impact on stock prices. Several studies have found negative relationship between inflation and share prices. Industrial production would lead to a rise in stock prices thus implying positive relationship. Increase in foreign exchange reserves lead to a positive effect on stock market movements. In majority of studies interest rate wasfound to be negatively related with stock prices.

العلاقة التبادلية بين سعر الصرف وأسعار الأسهم دراسة تطبيقية في سوق اسطنبول للأوراق المالية للمدة 2005-2020

The study aims to analyzing the reciprocal relationship between the nominal exchange rate of the Turkish lira versus the U.S. dollar and the stock prices of the companies listed on the Istanbul Stock Exchange (ISE) expressed in the general market index for the period from 2005 to 2020 with 192 monthly observations, based on the traditional theory and the theory of portfolio balance model in theoretical interpretation for that relationship, aiming to identify the effect of the exchange rate on stock prices, as well as to analyze the causal relationship between those variables and to identify which of them is the cause or which is the result, using the Autoregressive Distributed Lag (ARDL) model. The research found that the exchange rate has a positive effect on stock prices in the long term, despite the emergence of the negative impact in the short term, but the long-term relationship has corrected the course of the short-term relationship with a time period not exceeding one month, in addition to proving that this relationship takes one direction. From the exchange rate towards stock prices, that is, the exchange rate is the reason and stock prices are the result, therefore the results of this research helps investors to predict future trends of stock prices depending on the exchange rate changes, and it also enables the companies, especially those with foreign transactions, to manage price risks the exchange rate in order to avoid its negative impact on its share price, as it represents an obstacle to achieving its main goal of maximizing the share price

Scaling, Unwinding and Greening QE in a Calibrated Portfolio Balance Model

Scaling, Unwinding and Greening QE in a Calibrated Portfolio Balance Model

Do immigrants’ funds affect the exchange rate?

AbstractUsing annual data over 1966–2014 from the Citizenship and Immigration statistics archives of Canada and constructing a time series for the funds brought into Canada by immigrants, we investigate whether these funds affect the exchange rate of Canada. We employ the ARDL bound testing (Pesaran and Shin, Econometrics and economic theory in the 20th century: The Ragnar Frisch centennial symposium. Cambridge, UK: Cambridge UP, 1999), dynamic OLS (Stock and Watson, Econometrica, 1993, 61, 783) approaches to cointegration. 2SLS and GMM methods are also applied to estimate the portfolio balance models of the exchange rate. Estimated results indicate a long‐run relation between immigrants’ funds and the exchange rate with immigrants' funds leading to a significant appreciation of the exchange rate in Canada. These results are robust to different estimation methods and an alternative proxy measure for the funds brought into Canada by immigrants.

DETERMINANTS OF EXCHANGE RATE: A REVIEW BASED STUDY

Purpose: The study aims to find out the suitable model for exchange rate determination and economic variables which affect movement of exchange rates by reviewing available studies. Design/ methodology/ approach: The study is descriptive and is entirely based on secondary data. Findings: There is no one perfect model which can determine exchange rate movements. Inflation, interest rates, money supply, current account balance, oil prices are among the macroeconomic variables and currency order flow is microeconomic variable which affect exchange rates. KEY WORDS: Exchange rate, monetary model, portfolio balance model, IRPT model,PPP model, macroeconomic factors, macroeconomic & microstructure factors.

A Portfolio Balance Model of the Open Economy

This paper develops a framework in which to investigate the effects of macroeconomic policies. The key building blocks are those of Metzler (1968, 1973) in the form of a wealth saving relation and the emphasis on portfolio considerations; the model in its dynamic aspects is extended in a manner suggested in the work of Foley/Sidrauski (1971) and Mussa (1973), where the asset accumulation implied by short-run equilibrium is pursued over time.

Stock prices, exchange rates and portfolio equity flows

PurposeThe purpose of this paper is to develop a new framework to test the hypothesis that portfolio model predicts a negative correlation between stock prices and exchange rates in a trivariate transmission channel for foreign portfolio equity investment.Design/methodology/approachThis paper utilizes panel data for eight economies to extend the Dumitrescu and Hurlin (2012) Granger non-causality test of heterogeneous panels to a trivariate model by integrating the Toda and Yamamoto (1995) approach to Granger causality.FindingsThe evidence suggests that stock prices Granger-cause exchange rates and portfolio equity flows Granger-cause exchange rates. However, the overall panel evidence casts doubt on the explicit trivariate model of portfolio balance model. The study shows that Indonesia may be the only case where stock prices affect exchange rates through portfolio equity flows.Research limitations/implicationsThe proposed test does not account for potential asymmetries or structural shifts associated with the crisis period. To isolate the impact of the Asian Financial crisis, this paper rather splits the sample period into two sub-periods: pre- and post-crises. The sample period and countries are also limited due to the use of the balance of payment statistics.Practical implicationsThe study casts doubt on the maintained hypothesis of a trivariate transmission channel, as posited by the portfolio model. Policy makers of an economy may integrate capital market and fiscal policies in order to maintain stable exchange rate.Originality/valueThis paper integrates a portfolio equity inflow variable into a single framework with stock price and exchange rate variables. It extends the Dumitrescu and Hurlin’s (2012) bivariate stationary Granger non-causality test in heterogeneous panels to a trivariate setting in the framework of Toda and Yamamoto (1995).

Euro Area Quantitative Easing in a Portfolio Balance Model with Heterogeneous Agents and Assets

We develop a portfolio balance model to study the effects of Quantitative Easing (QE) on international financial asset returns through the portfolio balance channel. Our two-country model features heterogeneity in assets and investor preferences. Both are crucial for a meaningful model-based impact assessment of QE. Preferences for asset maturity, asset class (bonds, equities and currencies) and whether an asset is issued at home or abroad influence the substitutability of assets, which drives the portfolio balance effect of central bank asset purchases. We calibrate the two countries in our model to the euro area and a representative sample of rest-of-the-world (ROW) countries in order to estimate the international impact of the ECB’s asset purchase program announced in January 2015. When simulating our model, we find that central bank asset purchases decrease both domestic and foreign yields. While the effects of QE on domestic yields and the exchange rate are rather modest and smaller than commonly assumed in the literature, domestic stock prices increase substantially.

A study of the interaction between exchange rates and stock market prices

This study examines the interaction between exchange rates and stock market prices in some developed economies (viz. Australia, Japan, Canada, UK, USA, Hong Kong, and Switzerland) and some emerging economies (China and Brazil). The study period considered is from 01/01/2007 to 23/07/2012, and the study is based on weekly data. The results of the study provide evidence of uni-directional Granger causality of exchange rates on stock market returns, except in cases of China and Canada. The results support the flow-oriented model, which suggests that changes in exchange rates cause changes in stock prices, and provide evidence against the portfolio balance model, which suggests that stock market movements cause changes in the exchange rate.

A study of the interaction between exchange rates and stock market prices

This study examines the interaction between exchange rates and stock market prices in some developed economies (viz. Australia, Japan, Canada, UK, USA, Hong Kong, and Switzerland) and some emerging economies (China and Brazil). The study period considered is from 01/01/2007 to 23/07/2012, and the study is based on weekly data. The results of the study provide evidence of uni-directional Granger causality of exchange rates on stock market returns, except in cases of China and Canada. The results support the flow-oriented model, which suggests that changes in exchange rates cause changes in stock prices, and provide evidence against the portfolio balance model, which suggests that stock market movements cause changes in the exchange rate.

Causal relationship of stock performance and macroeconomic variables: Empirical evidences from Brazil, Russia, India and China (BRIC)

The rise of BRIC (Brazil, Russia, India and China) in the global investment market is still too mysterious to investors. This paper attempts to investigate the causal relationship among quarterly returns of BRIC’s stock market indices using a set of pre-examined macroeconomic variables such as, economic growth (GDP), risk free rates (the U.S. t-bill rates), exchange rates against USD, international oil prices and inflation in order to understand the leading factor of BRIC’s stock market returns. This paper covers the sample period from 1996:Q4 to 2013:Q1. The error correction model and Granger causality approach were applied to investigate the relationship among the variables. The results indicate that none of the explanatory variables Granger cause stock market performance in China and India. In homogenous, there is Granger causality from BRIC’s stock market performance to the risk free rates and international oil prices. This finding implies that BRIC has strong market impact or purchasing power to influence the key raw input of an economy, as well as the largest risk free investment instrument in the world. Generally, the Fed model, international trading effect and portfolio balance model are inapplicable to BRIC. The safest investment guidance for investors is to follow the changes in oil prices to forecast the movement in stock performance in Brazil. This is because there is an actual sign (from the error correction model) and significant pairwise Granger causality between stock market returns and oil prices in Brazil. Key words : stock market performance, macroeconomic variables, granger causality, risk free rates; unit root tests, cointegration tests

The nexus between stock price and foreign exchange rate: validating the portfolio-balance model in Nigeria

The relationship between stock price and foreign exchange (forex) rate has been a controversial issue over the years. This study examines the nexus between stock prices and forex rates in Nigeria from January 1985 to December 2014. It applies the Johansen co-integration, Toda-Yamamoto Granger non-causality and correlation tests. The empirical results reveal that there is presence of co-integration between stock prices and forex rates and unidirectional causality from forex rates to stock prices with positive correlation. This study did not validate the proposition of the portfolio-balance model in Nigeria but it provides substantiated evidence in favour of the traditional-flow model.

Exit Strategies, Capital Flight and Speculative Attacks: Europe's Version of the Trilemma

In the winter 2011/12 a wave of internal capital flight prompted the ECB to abandon its exit strategy and to announce an unprecedented monetary expansion. We analyze this episode in several dimensions: (i) by providing an event-study analysis covering key variables from national central banks' balance sheets, (ii) by rationalizing their patterns in a portfolio balance model of the exchange rate, augmented by institutional characteristics of the TARGET2 system, and (iii) by proposing a theory-based index of exchange market pressure within the euro area. We argue that the euro area entails an inherent policy trilemma that makes it prone to speculative attacks.

The nexus between stock price and foreign exchange rate: validating the portfolio-balance model in Nigeria

The nexus between stock price and foreign exchange rate: validating the portfolio-balance model in Nigeria

Central banks and macroeconomic policy choices: Relaxing the trilemma

Abstract Macroeconomic policy choices in open economies are constrained by the trilemma according to which the objectives of exchange rate stability, monetary independence and capital mobility cannot be attained jointly. This paper shows that foreign exchange interventions provide an effective instrument to relax the trilemma. An active reserve policy allows central banks to pursue independent monetary and exchange rate policies when the capital account is liberalised. We use the framework of the portfolio balance model to show that exchange market interventions may substitute for capital controls. Both allow a country to achieve the other two objectives of the trilemma. Our empirical analysis of a large country panel data set covering the period 1970–2010 confirms this theoretical insight: the weighted sum of the three trilemma objectives increases in the degree of foreign exchange market intervention. The capacity to relax the trilemma constraint has increased over time and has been most effective in emerging markets.

Valuation effects and long-run real exchange rate dynamics

This paper uses the Johansen test for cointegration to check the prediction of a portfolio balance model that predictable valuation effects are associated with a saddle-path dynamic relationship between the net foreign asset position and the real exchange rate. The analysis uses newly constructed quarterly series on the net foreign position as a percentage of the nominal gross domestic product, together with data on real effective exchange rate indices for a sample of developed countries which borrow in their own currency. The results indicate that the net foreign asset position and the real exchange rate are not cointegrated for all the countries in the sample. The rejection of saddle-path dynamics suggests that predictable valuation effects are quantitatively small in developed countries. The rejection of cointegration suggests that the net foreign asset position is not a determinant for long-run real exchange rates in developed countries.

Portfolio Balance Model for Emerging Market Countries

Portfolio Balance Model for Emerging Market Countries

Home bias, risk differential, and cultural spatial spillover effects

This paper aims to uncover the role of heterogeneity and spillover effects of return and risk on home bias associated with common background characteristics of trading countries. We adopt a spatial panel model to utilize uniquely created weight matrices and capture the spatial spillover effects of the common background characteristics. A modified definition of home bias is used to explore the role of market risks associated with the common characteristics of cross-border portfolio flows in an international portfolio balance model. Using annual panel data of 17 countries spread over three different regions (i.e., Asia, Europe, and others) for the 2002–2012 period, evidence strongly supports our hypothesis that the effects of the return and risk differentials of trading countries on home bias depend on the correlation of each of the common characteristics with return and risk.

Expansive monetary policy in a portfolio model with endogenous asset supply

This paper develops an open economy portfolio balance model with endogenous asset supply. Domestic producers choose an optimal capital structure and finance capital goods through credit, bonds and equity assets. Private households hold a portfolio of domestic and foreign assets, shift balances depending on risk–return considerations, and maximise real consumption in accordance with the law of one price.Within this general equilibrium model, it will be shown that central bank interventions may promote an inefficient international allocation of real capital. The application of expansive monetary interventions throughout the course of economic crises maintains the domestic stock of real capital at the cost of inflation, currency devaluation, distortions of interest rates and asset prices, and risk clusters on the central bank's balance sheet.