Joint with Center for Economic Design (CED)

 

May 23, 2008

 

"Global Portfolio Rebalancing under the Microscope"

Harald Hau and Helene Rey

 

Abstract

The dramatic increase in gross stock of foreign assets and liability has revived interest in the portfolio 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 then 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 triggers 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. We highlight the role of this evidence for international asset price dynamics and the international financial adjustment mechanism.