Essays in international finance : international capital flows, equity and FX markets

This thesis presents three papers in the field of international finance and provides a study of the international capital flows from a macro-finance perspective. The first paper is an empirical investigation of the relative importance of hot money in bank credit and portfolio flows from the U.S. to 18 emerging markets over the period 1988-2012. We deploy state-space models a la Kalman filter to identify the unobserved hot money as the temporary component of each type of flow. The analysis reveals that the importance of hot money relative to the permanent component in bank credit flows has significantly increased during the 2000s relative to the 1990s. This finding is robust to controlling for the influence of push and pull factors in the two unobserved components. The evidence supports indirectly the view that global banks have played an important role in the transmission of the global financial crisis to emerging markets, and endorses the use of regulations to manage international capital flows. The second paper examines the role played by cross-border equity, bond and bank credit flows versus international trade in the transmission of the U.S. subprime crisis to equity markets worldwide. We estimate vector autoregressive models with exogenous global factors using monthly data on 36 emerging and developed countries. The results from an eclectic methodology that includes causality tests, generalized impulse responses and forecast error variance decompositions indicate that the subprime crisis is mostly transmitted through bank credit rather than portfolio flows and international trade. The results are robust to altering the exogenous versus endogenous vectors of variables, to measuring equity prices in U.S. dollars or local currency, to averaging the data across countries versus averaging the parameters from individual country estimation, and to redefining the start date of the crisis. The findings endorse the use of banking regulation and capital controls as part of the policy toolkit to limit financial vulnerability. Finally, the third paper examine the two steps and the prediction of Uncovered Equity Parity (UEP). Within a portfolio-rebalancing framework, UEP predicts that countries with strong equity markets should experience a currency depreciation, as higher total returns in domestic equity market will cause foreign investors to repatriate some of their investments to decrease their exchange rate exposure, leading to exchange rate depreciation. Using daily equity flow data including all the recorded trades of foreign investors for six Asian EMs from the 1990s to 2013, we find a positive rather than a negative relationship between currency and equity returns. We document that it is because the foreigners in aggregate chase returns rather than rebalance their portfolios in emerging markets, while foreign equity flows do cause exchange rate movements in the same direction. Thus, we unveil another side of UEP. Additionally, we find little evidence that foreign equity flows respond to past currency returns, suggesting that foreign equity investors only use local currency as a vehicle investing in emerging markets.