DP15617 Global Portfolio Rebalancing and Exchange Rates
We examine international equity allocations at the fund level and show how excess foreign returns influence portfolio rebalancing, capital flows and currencies. Our equilibrium model of incomplete FX risk trading where exchange rate risk partially segments international equity markets is consistent with the observed dynamics of equity returns, exchange rates, and fund-level capital flows. We document that rebalancing is more intense under higher FX volatility and
find heterogeneous rebalancing behavior across different fund characteristics. A granular instrumental
variable (GIV) approach identi es a currency supply elasticity suggesting that an equity outflow shock of US$7.1 billion depreciates the dollar by 1 percent.