DP6901 Global Portfolio Rebalancing Under the Microscope

Author(s): Harald Hau, Hélène Rey
Publication Date: July 2008
Keyword(s): capital flows, home bias, International Finance
JEL(s): F32, G15
Programme Areas: International Macroeconomics, Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=6901

The dramatic increase in gross stock of foreign assets and liability has revived interest in the portfolio balance theory of international investment. Evidence on the validity of this theory has always been scarce and inconclusive. The current paper derives testable empirical implications from microeconomic foundations, which we confront with a new comprehensive data set on the stock allocations of approximately 6,500 international equity funds domiciled in four different currency areas. The disaggregated data structure allows us to examine whether foreign exchange and equity risk measures trigger the predicted rebalancing behavior at the fund and stock level. The data provide strong support for portfolio rebalancing behavior aimed at reducing both exchange rate and equity risk exposure.