Appendix 1: Cross Border Capital Flows and Foreign Exchange Market Activity 

A key feature of the international financial system over at least the last decade has been the 

unprecedented expansion of cross-border financial transactions with wide-ranging implications 

for asset prices, economic performance, global imbalances and exchange rate determination. 

Often called the globalization of finance, cross-border capital transactions have grown so 

quickly, both in absolute size and relative to global GDP, that they dwarf in size global trade in 

goods and services. 

A variety of explanations has been given for the rapid growth of global financial activity: (1) 

rapid growth and diversification of investor bases, including those of private institutional money 

under management, rapid growth of hedge funds, and increased activity by official monetary 

sources; (2) growing internationalization of investment patterns as investors search for higher 

yields and greater portfolio diversification; (3) technological advances and liberalization of 

financial markets, each of which has improved and expanded market access to global financial 

services; and (4) the rapid expansion of savings, particularly in emerging markets. This 

appendix focuses on a few key developments (size of global financial markets, volume of daily 

foreign exchange activity, funds under institutional money management, selected investment 

activity by official sources, and net capital inflows and outflows) to highlight some broader 

trends in global financial activity over the past decade. 

Size of Global Capital Markets 

As of end-2006, the estimated value of the world’s outstanding bonds, equities, and banking 

assets was $190.4 trillion, roughly four times the size of global GDP.1

 Eight-five percent of 

these financial assets were attributable to advanced economies but the share attributable to 

emerging markets has grown steadily over the last five years, from 9.6 percent of the total to 15.2 

percent. 

After reaching $150 trillion in 2001, the total 

size of financial markets fell to $124 billion in 

2003, mostly as a result of declining 

commercial bank assets. Equity market 

capitalization declined in 2002, but then more 

than doubled from 2002 to 2006. The 

outstanding value of fixed income securities in 

circulation globally, particularly that of 

privately-issued debt instruments, grew steadily 

throughout the period,. In the three years from 

2003 to 2006, total global financial assets 

increased in value by 53 percent, or $65 trillion. Over the same period, global GDP increased by 

$12 trillion, and the value of global trade in goods and services increased by $5.4 trillion.2

 

 

1

 See page 139 of the IMF’s Global Financial Stability Report, October 2007. 2

 See page 231 of the IMF’s World Economic Outlook, October 2007. 

Value of world capital markets (trillions of U.S. dollars)

150.1 150.4

123.8

144.7

151.8

190.4

100

110

120

130

140

150

160

170

180

190

200

2001 2002 2003 2004 2005 2006
2

Global Foreign Exchange Market 

Average Daily Turnover

3210

1950

1420

1650

1150

880

0 1000 2000 3000 4000

1992 

1995 

1998 

2001 

2004 

2007

Billions of Dollars

Daily Foreign Exchange Trading 

Since 1992, the Bank for International 

Settlements (BIS) has been collecting 

data on foreign exchange and derivatives 

markets activity.3 Its 2007 survey put 

average daily turnover at $3.2 trillion, a 

71 percent increase in daily volume 

since 2004. Average daily volume has 

doubled since 1998, when it was $1.65 

trillion, and it has nearly quadrupled in 

the 15 years since 1992, when it was 

$880 billion. If OTC derivatives market 

activity also is included, then the average daily volume of foreign exchange activity rises to $5.3 

trillion. These figures are for all currencies, with any given transaction involving two currencies. 

The U.S. dollar is involved in 86.3 percent of all transactions. The euro is involved in 37 percent 

of all transactions, for daily market activity of $1.2 trillion. The Japanese yen is involved in 16.5 

percent of all transactions, for average daily market activity of $530 billion.4

 On a full-year 

basis, assuming 250 business days, foreign exchange volume approaches $800 trillion. How 

much of this is the result of customers’ taking positions in foreign assets as opposed to trading by 

financial institutions for their “own account” is not known. 

Money under Institutional Management 

Much of this foreign exchange activity 

involves cross-border investment decisions by 

institutional investors in mature financial 

markets: pension funds, insurance companies, 

and mutual funds. The value of assets under 

professional management by these entities has 

grown more that five-fold since the early 

1990s, from an estimated $11 trillion in 1990 

to over $60 trillion in 2006. Much of the 

increase is attributable to the expansion of 

funds of under investment company management, followed closely by the expansion of pension 

fund assets. 

Not only is a much larger amount of money under professional management, but both 

institutional and retail investors are much more inclined today to diversify their investments 

across currencies than across asset classes. This ongoing decline in “home bias” (the tendency to 

invest predominantly in one’s own market and own currency) is also a major factor in the 

growing internationalization of global capital flows. Although it is difficult to know precisely 

how much of this money under institutional management is placed in foreign financial assets, an 

 

3

 Bank of International Settlements, Triennial Central Bank Survey of Foreign Exchange and Derivatives Market 

Activity in April 2007, September 2007; http://www.bis.org/publ/rpfx07.htm.

4

 The percentages sum to 200 percent because there are two currencies involved in each transaction. 

Major Industrial Countries: Assets of Institutional Investors (In trillions of U.S. dollars) 

0

10

20

30

40

50

60

70

1990 1995 2000 2005 2006

Sources: International Financial Services London; and OECD

 Insurance companies Pension funds Investment companies
3

approximation based on the international bond/equity allocations of advanced economy pension 

funds suggests perhaps $14 trillion of the $60 trillion under management is placed in foreign 

assets.5 Depending on how often investment positions are turned over during the course of a 

year, some multiple of the $14 trillion likely flows through foreign exchange markets each year 

as a result of changing investment positions of institutional money managers. 

Official Investment Activity 

Reserves: 

Official institutions, mostly from emerging market economies, also have greatly increased their 

participation in global financial markets. This has been especially so since the financial crises of 

1997/98, as monetary authorities in many emerging markets have chosen to stockpile foreign 

exchange reserves, often far in excess of traditional thresholds.6

 As of end-June 2007, IMF data 

show emerging market foreign exchange reserves to have totaled $5.7 trillion, roughly a 

threefold increase since 2000. The majority of these reserves are held in U.S. dollars, though a 

significant share is held in euros. 

Emerging Asia, and China in particular, 

account for the largest share of foreign 

reserve accumulation, but other regions 

including Latin America, Russia, and oil 

exporters in the Middle East also have 

sharply boosted their reserves over the last 

1-3 years. 

Sovereign Wealth Funds: 

In addition, some official entities are 

adding to cross-border investment totals 

through high foreign currency exposure 

sovereign wealth funds (SWFs). 

 

Aggregate Cross-Border Capital Flows

Lastly, the sum of total net capital inflows and outflows, which includes direct investment, 

portfolio investment, reserve accumulation, and other investment flows, has tripled over the last 

10 years to nearly $13 trillion. Virtually every economic area has experienced a roughly threefold increase in inflows and outflows over the past decade, with the vast majority of the increase 

occurring within just the last five years. 

 

5

 See Table 2.1, page 71, of the IMF’s Global Financial Stability Report, April 2007. 6

 See, for example, “The Adequacy of Foreign Exchange Reserves”, Annex 3 of the December 2006 semi-annual 

Report on International Economic and Exchange Rate Policies. 

Change in International Reserves (USD millions), year to Sept 07

89,569

159,181

81,615

14,843

445,160

0 100,000 200,000 300,000 400,000 500,000

Brazil

Russia

India

China

Argentina

Source: National Central Banks
4

 Total of Net Capital Inflows and Outflows 

 ($ Billions) 

 

 Source: IMF World Economic Outlook, October 2007 

Cross-border capital flows swamp global trade flows. Although there are no adequate 

comprehensive data on global gross capital flows, the Treasury’s International Capital Reporting 

System (TIC) shows gross purchases and sales in long-term US securities alone totaled over $52 

trillion in 2006. In comparison, total annual world trade in goods and services is less than $30 

trillion. 

Foreigners’ Gross Purchases of US Long-Term Securities 21,101 ($ Billions) 

Foreigners’ Gross Sales of US Long-Term Securities 19,959 

U.S. Residents’ Purchases of Foreign Securities 5,815 

U.S. Residents’ Sales of Foreigners Securities 5,568 

Total Gross Transactions (Inflows and Outflows) 52,443 

NET of Above 895

 Source: Treasury’s TIC System; Data for 2006. 

Conclusion

This appendix highlighted a few areas in cross-border financial activity to give some notion of 

the relative magnitude of portfolio capital flows and international investment positions and how 

they have and continue to become a much larger part of exchange rate determination. Additional 

measures of international financial activity, such as margin trading, swaps, international bond 

offerings and syndications, could supplement the analysis but the main point would remain the 

same: any full accounting of the influences affecting exchange rates, and especially exchange 

rates determined in large, liquid markets, should adequately focus on activity in international 

financial markets. 

 1996 2001 2006 % 

Change 

U. S. 964.5 1165.5 2914.8 301.9 

Japan 251.1 188.3 342.0 35.7 

Euro 1429.0 1536.4 4045.5 283.1 

UK 691.3 888.1 2444.6 353.6 

Canada 93.0 133.1 272.0 292.5 

EmergMarkets/ 

Devel Ctries 

732.4 397.3 2717.0 371.0 

Total 

(of above) 

4162.3 4308.7 12735.9 306.0