Portfolio Balance Theory Research Articles

The dynamic relationship between ASEAN+6 exchange rates and stock markets: application of the ARDL model

PurposeThis study investigates the short- and long-run relationship between stock prices and exchange rates in the Association of Southeast Asian Nations (ASEAN)+6 markets. In the short run, support is found for both the theory of a goods market where exchange rates influence stock returns and portfolio balance theory, where stock returns influence exchange rates.Design/methodology/approachThe co-integration approach of linear and nonlinear augmented autoregressive distributed lag (ARDL) models was applied to daily data from 2 January 2017 to 30 June 2023.FindingsThe findings provide evidence that the goods market theory is supported solely in Indonesia and Singapore, while the portfolio balance theory is supported for Australia, China, India and Malaysia.Practical implicationsPolicymakers and investors should seriously consider the importance of the study findings. The results show that all ASEAN+6 countries experience a short-term interaction between the two markets. This illustrates that exchange rates and stock price movements play vital roles in other markets. Stakeholders, particularly policymakers, should be aware of this critical relationship.Originality/valueThis is the first study to dynamically examine how the ASEAN+6 framework influences currency rates and stock markets.

Exchange Rate Volatility and Export Performance: Case of Malaysia

Purpose: The aim of the study was to investigate the exchange rate volatility and export performance: case of Malaysia
 Methodology: This study adopted a desk methodology. A desk study research design is commonly known as secondary data collection. This is basically collecting data from existing resources preferably because of its low cost advantage as compared to a field research. Our current study looked into already published studies and reports as the data was easily accessed through online journals and libraries.
 Findings: Exchange rate volatility negatively impacts Malaysia's exports, reducing both volumes and revenues. Stable exchange rates are crucial for export competitiveness and attracting foreign investment. Effective hedging and exchange rate policies are recommended to mitigate volatility's adverse effects. Macroeconomic stability and structural reforms are essential for Malaysia's resilience to external shocks. Managing exchange rate volatility is key for sustaining Malaysia's export-led growth and fostering economic development.
 Unique Contribution to Theory, Practice and Policy: Portfolio balance theory, j-curve theory & competitive devaluation theory may be used to anchor future studies on the exchange rate volatility and export performance: case of Malaysia. Malaysia can provide practical insights into how exporters can effectively integrate risk management strategies into their operations to mitigate the adverse effects of exchange rate volatility. Malaysia can serve as a model for proactive policy responses to exchange rate volatility, offering lessons and strategies that can be adapted by policymakers in other emerging economies.

Currency Substitution and General Business Indicators in Nigeria

Purpose: This paper examines the effects of currency substitution on general business indicators in Nigeria. Theoretical framework: This paper is based on portfolio balance theory which is concerned with interest rate adjustment and achieving the market equilibrium on currency substitution aggregate. Design/Methodology/Approach: The paper employed appropriate econometric techniques such as the cointegration and error correction model (ECM) approach to examine the long run and short run attendant relationships. Findings: Empirical findings from this study indicate that there is a long run relationship between currency substitution and general business indicators variables as inflation, interest rate differentials, and exchange rate depreciation in Nigeria, the magnitudes of the impact of each are weak. Research, Practical & Social implications: The construction and analysis of currency substitution and general business environment by this study have provided relevant information for Nigerian economy in preparing for substantial currency substitution that would give clear understanding of the aggregate business environment on existing currency substitution policy that may lessen the anxiety of the apparent environmental challenges faced by the countries, and this will further provide policy directions for future currency substitution reforms in the various segment of the economy. Originality/Value: The originality of this study lies in its analysis of currency substitution and general business environment. Furthermore, the study highlights the relevance of tackling regulatory issues to ensure the safe and effective use of currency substitution.

Systematic Review of Nexus between Exchange Rate Fluctuations and Stock Market Price Movements: Flow Oriented Theory, Stock Oriented Theory and Portfolio Balance Theory

The study investigated literatures on nexus between exchange rate fluctuations and stock market price movements: flow oriented theory, stock oriented theory and portfolio balance theory. It was discovered that many studies predominantly found out statistically significant positive nexus between exchange rate fluctuations and stock market price movements (Parsva & Lean, 2017; Mechri, Ben Hamad, De Peretti & Charfi, 2018; Morales-Zumaquero & Sosvilla-Rivero, 2018; Bahrnani-Oskooee & Saha,2016; Ho & Huang,2015; Sui & Sun,2016; Mroua & Trabelsi,2019; Nazakat & Kashif,2017; Yildirim & Adali, 2018; Fapetu, Adeyeye, Seyingbo & Owoeye,2017; Okechukwu, Mbadike, Geoffrey & Ozurunma,2019; Bagh, Azad, Razzaq, Liaqat & Khan,2017; Alzyoud, Wang & Basso, 2018) while very scanty and few studies revealed a negative significant relationship and statistically insignificant. Various studies conducted shows different results on asymmetric and symmetric effects and causality: bidirectional, unidirectional and no causality between exchange rate fluctuations and stock market price movements. Some results support the ?ow oriented theory, some are for the stock oriented theory and portfolio balance theory while others believe that three theories are functional in an economy. Variation in these studies could be as a result of methodology used, market condition, risk and other factors that are peculiar to each economy. The study discovered other factors namely GDP of a country, level of employment, companies business internal ?nancing structure, investment inflow, inflation rates, oil prices, government expenditure, in?ation rate, interest rate, and exchange rate that have effect on stock market movements. The empirical studies examined recommended as follows: Regulators should consider developing sound policy measures to prevent ?nancial risk. The public who desire to invest must utilize the information of important macro-economic variable in particular exchange rates vol

Volatility spillover analysis between stocks and exchange rate markets in short and long terms in East European and Eurasian countries

PurposeThis paper researches a bidirectional volatility transmission effect between stocks and exchange rate markets in the six East European and Eurasian countries.Design/methodology/approachResearch process involves creation of transitory and permanent volatilities via optimal component generalized autoregressive heteroscedasticity (CGARCH) model, while these volatilities are subsequently embedded in Markov switching model.FindingsThis study’s results indicate that bidirectional volatility transmission exists between the markets in the selected countries, whereas the effect from exchange rate to stocks is stronger than the other way around in both short-term and long-term. In particular, the authors find that long-term spillover effect from exchange rate to stocks is stronger than the short-term counterpart in all countries, which could suggest that flow-oriented model better explains the nexus between the markets than portfolio-balance approach. On the other hand, short-term volatility transfer from stock to exchange rate is stronger than its long-term equivalent.Practical implicationsThis suggests that portfolio-balance theory also has a role in explaining the transmission effect from stock to exchange rate market, but a decisive fact is from which direction spillover effect is observed.Originality/valueThis paper is the first one that analyses the volatility nexus between stocks and exchange rate in short and long term in the four East European and two Eurasian countries.

Nonlinear bidirectional multiscale volatility transmission effect between stocks and exchange rate markets in the selected African countries

This paper investigates the multiscale bidirectional volatility spillover effect between the national stocks and exchange rate markets in four African countries – Nigeria, South Africa, Egypt and Morocco. Our computations involve the wavelet transformation of the empirical series, creation of the regime-dependant conditional volatilities via MS-GARCH model and measurement of the volatility spillover effect in the quantile regression framework. We find an evidence of the bidirectional volatility spillover effect, but the volatility impact from exchange rate market to stock market is stronger in all the African countries, except Nigeria. Regarding the direction from stocks to exchange rate, we report that volatility spillover effect is the strongest in South Africa, because Johannesburg stock exchange is the most developed and liquid market. As for the reverse direction, the spillover effect is recorded in longer time-horizons in the Egyptian and Moroccan cases, which indicates to flow-oriented model, while for South Africa, the effect is found in shorter time-horizons, which is in line with the portfolio-balance theory. In South Africa, investors should protect themselves against exchange rate risk in shorter time-horizons, in Morocco and Egypt in longer time-horizons, while in Nigeria, hedging against exchange rate is not needed.

A new approach to exchange rate forecast: The role of global financial cycle and time‐varying parameters

AbstractThe exchange rate disconnect puzzle argues that macroeconomic fundamentals are not able to accurately predict exchange rate. Recent studies have shown that the puzzle could be upturned if: (a) the dataset is structured in a panel form; (b) the model is based on the portfolio balance theory (PBT); (c) factor models are employed and (d) time‐varying parameter (TVP) regression is used. This study combines these strands of the literature. Essentially, the study conjectures that Global Financial Cycle (GFCy), drawing inspiration from PBT, has some predictive information content on exchange rate. Using dataset from 25 countries, we produced some mixed results. On the whole, the GFCy is able to produce lower forecast error, as compared to the that of benchmark model. However, its effectiveness is dependent upon the regression type (TVP vs. Panel Fixed Effect); forecast horizons (short vs. long); the sample period (early vs. late) and measures of GFCy. The results are robust to a number of checks.

Portfolio Balance Approach to Asymmetries, Structural Breaks and Financial Crisis: Testing a Model for Nigeria

This study tests the Portfolio Balance Theory (PBT) for Nigeria for the period starting from September 1997 to September 2018. It extends the hypothesized linear inverse relationship between exchange rate and stock price to include asymmetries and structural breaks. It further examines the impact of the 2008 global financial crisis on the PBT to determine its stability after the crisis. The full sample results show that the PBT holds for Nigeria and asymmetries and structural breaks matter in the nexus between stock price and exchange rate. However, the impact of stock price on exchange rate diminished in the long-run with the advent of the 2008 global financial crisis, thus eroding the relative consistency of the PBT after the crisis. The sensitivity of the Nigerian exchange rate to stock price changes calls for the strengthening of the stock market performance through relevant policies including the enhancement of portfolio diversification and risk-hedging assets. The role of asymmetries should not also be jettisoned in predicting exchange rate with stock prices to obtain accurate forecast results.

Modelling stock price–exchange rate nexus in OECD countries: A new perspective

This paper subjects the Portfolio Balance Theory to empirical scrutiny using panel data of OECD countries. Thus, it examines the response of exchange rate to stock price changes contrary to the prominent practice in the literature where the former is hypothesized as the predictor. Consequently, it formulates a dynamic nonstationary heterogenous panel data model that corrects for any inherent weak endogeneity problem that may result from such reverse causality while also accounting for nonstationarity and heterogeneity features typical of Large N and Large T panels. It also tests for the role of asymmetries in the nexus in response to the increasing evidence in the literature suggesting that most financial series tend to exhibit leverage effects. Given the significance of Euro currency for OECD, the study further partitions the full data into Euro and Non-Euro areas. In addition, separate regressions are conducted for the pre- and post-Global Financial Crisis (GFC) in order to account for the role of financial crisis in the nexus. For robustness, the study considers both nominal and real variables and multiple data frequencies. In all, the result lends support to the Portfolio Balance Theory for the full OECD, the Euro area, and the non-Euro area, albeit with lesser evidence for the latter. Also, the validity of the theory became more evident after the global financial crisis while both long-run and short-run asymmetries are present in the nexus regardless of the data sample. Interestingly, findings that give rise to these conclusions are insensitive to different data frequencies, variable measurements and lag structures.

Public Debt with Valued Fiat Currency in a Model of Economic Growth

The paper incorporates Tobin's portfolio balance theory into an overlapping generations model of growth with endogenously valued money in which fiscal policy and/or monetary policy can change the steady state level of the capital stock. The optimal inflation rate that maximizes the steady-state capital stock is a function of the nominal interest rate and the income tax rate. For example, when the nominal interest rate equals 6%, government balances its budget and sets the average income tax rate to be 20%, then the optimal inflation rate for the model economy is about 3.39%. The model can be used to demonstrate how open market intervention could hinder economic growth when the targeted inflation rate is not equal to the optimal inflation rate. In the model, money is neutral but not super neutral. In contrast, with most models that explain real effects of inflation, anticipated changes in the inflation rate have a real effect in this model. This occurs because money and nominal government debt enter the economy not as a helicopter drop but as seigniorage and the Ricardian Equivalence does not hold.

FACTOR MODELS AND TIME‐VARYING PARAMETER FRAMEWORK FOR FORECASTING EXCHANGE RATES AND INFLATION: A SURVEY

AbstractA survey of models used for forecasting exchange rates and inflation reveals that the factor‐based and time‐varying parameter or state space models generate superior forecasts relative to all other models. This survey also finds that models based on Taylor rule and portfolio balance theory have moderate predictive power for forecasting exchange rates. The evidence on the use of Bayesian Model Averaging approach in forecasting exchange rates reveals limited predictive power, but strong support for forecasting inflation. Overall, the evidence overwhelmingly points to the context of the forecasts, relevance of the historical data, data transformation, choice of the benchmark, selected time horizons, sample period and forecast evaluation methods as the crucial elements in selecting forecasting models for exchange rate and inflation.

Does Bilateral Market and Financial Integration Explains International Co-Movement Patterns1

This study aims to explore the relationship between market integration, foreign portfolio equity holding and inflation rates on international stock market linkages between Pakistan and India. To measure stock equity interlinkage, we constructed international co-movement index through rolling beta estimation. Market integration variable between these two countries is constructed using the International Capital Asset Pricing Model (ICAPM). To check the impact of market integration, foreign portfolio equity holding and inflation rate on Pakistan-Indian stock market co-movement, we applied autoregressive distributed lag (ARDL) estimation. ARDL estimation is applied due to different stationarity levels of the included variables. The level of convergence speed is measured by the introduction of error correction term (ECT) followed by variance decomposition analysis. Results of the study indicated presence of long term relationship among the included variables along with significance variance in bilateral co-movement due to inflation rate differential. The significance of inflation rate differences between these two countries are in accordance with portfolio balance theory stating that investors possess information about the macroeconomic variables thereby readjusting their portfolios for effective diversification.

Dynamics of effective portfolio diversification among EFA markets: a heterogeneous panel analysis

This paper focuses on the role of various factors of international co-movement patterns among equity returns of frontier and emerging markets. This study originated from Markowitz portfolio theory (1952) after which Grubel (1968) applied his concepts of diversification. This study fills the previous gaps by providing information about role that various factors have on international stock market co-movement rather than relying only on the return correlation. We constructed an international co-movement index through rolling beta estimation method followed by the estimation of bilateral market and economic variables. In the end, we applied panel data analysis to find level of variance that these included markets, financial and macro-economic variables have on stock market co-movement. Results highlight significant role of market size differential and macro-economic variables in explaining return co-movement of Pakistan with rest of the countries. Significance of our macro-economic factors are in accordance with portfolio balance theory presented by Kodres and Pritsker (2002) stating that investors possess information about macro-economic variables thereby readjusting their portfolios for effective diversification.

Stock Returns and Exchange Rate Nexus in Ghana: A Bayesian Quantile Regression Approach

AbstractThis paper presents analysis of the relationship and dependence structure between stock returns and exchange rates in Ghana using data of daily periodicity from January 4, 2011 to July 31, 2014. Analyses are conducted by means of Bayesian quantile regression (QR) technique and multiple causality tests. Our findings suggest high dependence of the equity market on the foreign exchange market in Ghana, and that the link between the two markets follows the international trade‐oriented model more than the portfolio balance theory. We report that among the six exchange rates used, only the cedi–dollar registers instantaneous effect on the equity market.

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The nexus between exchange rates and stock markets: evidence from the euro-dollar rate and composite European stock indices using rolling analysis

Both the goods market hypothesis and the portfolio balance theory, suggest a nexus between exchange rates and stock prices, albeit with a different direction of causality. This paper, using daily data, takes up the issue of the linkages between stock prices and exchange rates in the case of the euro-dollar rate and two composite European stock market indices: the FTSE Eurotop 300 and FTSE eTX All-Share Index. It addresses the causal ordering issue between the two markets using rolling unit root, cointegration and Granger causality tests. This methodological approach allows for the emergence of a clearer picture of the possible dynamic linkages between exchange rates and stock prices. The empirical results provide evidence of time-varying causality between the two markets.

Do Demand Curves for Currencies Slope Down? Evidence from the MSCI Global Index Change

Traditional portfolio balance theory derives a downward sloping currency demand function from limited international asset substitutability. Historically, this theory enjoyed little empirical support. We provide direct evidence by examining the exchange rate effect of a major redefinition of the MSCI Global Equity Index in 2001 and 2002. The index redefinition implied large changes in the representation of different countries in the MSCI Global Equity Index and therefore produced strong exogenous equity flows by index funds. Our event study reveals that countries with a relatively increasing equity representation experienced a relative currency appreciation upon announcement of the index change. Moreover, stock markets that are upweighted (downweighted) feature a higher (lower) permanent comovement of their currency with the basket of other MSCI currencies.

The Pula-dollar Exchange Rate and the Purchasing Power Parity in Botswana

For the small open economy of Botswana the PPP theory is validated in both the absolute and relative version for the Pula-Dollar exchange rate during the sample period 1992 third quarter to 2002 fourth quarter. The Pula-Dollar exchange rate is determined by the long-term trends in Botswana's Consumer Price Index (CPI) and the USA's CPI. The influence of the USA CPI is considerable. In the long-run there is no trade off between export competitiveness through devaluation and inflation. But as the speed of adjustment in the short-term towards long-term is slow, there is some flexibility for the exchange rate policy. The monetary policy can be used in the short-run to counter the inflation. There is no real appreciation of the Pula in the long run. This contradicts the portfolio balance theory which advocates that for a trade account surplus economy like Botswana the real exchange rate will appreciate through the limited demand for foreign assets. The lesson for the exchange rate policy for Botswana may be that it is better to keep more flexible the Pula-Dollar exchange rate than keeping it totally fixed.

Analysis of the relationship between the share market performance and exchange rates in New Zealand: A cointegrating VAR approach

This study employs the cointegrating VAR approach to characterise the relationships between the five exchange rates comprising the TWI and the share market in New Zealand. Weekly data covering January 1999 to June 2006 are analysed. The study discovers there are two types of long‐run relationship mimicking the portfolio balance and goods market theories. That implies there is bi‐directional causality in the foreign exchange and stock markets in both the short run and long run although different exchange rates may be implicated. In the long run, the empirical results for the relationship between the NZ‐US dollar exchange rate and the overall share market index support both the portfolio balance and goods market theories. In the short run, the portfolio balance theory is further supported by all the exchange rates but the goods market theory is supported significantly only by the NZ‐Australian dollar exchange rate. Thus the evidence is predominantly in support of the portfolio balance theory and that the firms most at risk of foreign exchange rate exposure are those that export to Australia.

Price and exchange rate determination between the Mekong river economies of Cambodia and Thailand

The authors use cointegration techniques to test for: (i) purchasing power parity (PPP) on the bilateral exchange rate between Cambodia and Thailand; and (ii) the existence of a long‐run equilibrium relationship between the official and parallel market exchange rates. The period under study is the phase of economic transition in Cambodia from central planning to a market economy during which inflation accelerated and then decelerated. The findings for the first test support the relative version of the PPP hypothesis. The second test draws on portfolio balance theory in the context of a dual exchange rate system. The findings indicate that parallel and official exchange rates are cointegrated, implying that during the period of monetary adjustment official and parallel market exchange rates depreciated in the same proportion over the long run.