THE PORTFOLIO FLOWS: Conclusions


We have used a new source of high frequency data on international portfolio flows to learn about how inflows behave and how they interact with returns. Our findings can be summarized as follows:

1. International portfolio inflows are slightly positively correlated across countries, and are more strongly correlated within regions. The correlation of flows in most regions, and particularly within Asia, rises strongly during the Asian crisis subsample, but not during the Mexican crisis subsample.

2. Inflows and outflows are highly persistent. The persistence is complex in the sense that a shock to inflows today is associated with slightly greater inflows over a long period of time.

3. There is very strong trend following in international inflows. The majority of the co-movement of flows and returns at quarterly or monthly intervals is actually due to returns predicting future flows.

4. There is also some ability for international inflows to forecast returns. In emerging markets, inflows predict on average to positive future returns. The majority of price increases do not occur over a short period of time, such as a few days. Rather prices seem to rise subsequent to inflows for a month or two. The limited time sample of our data prevents us from saying more about such low frequency predictability.

5. In developed markets, inflows do not forecast positive returns. At longer horizons, returns are negative and even statistically so.

6. Transitory inflows lead to partially transitory price increases.

7. The forecasting power of inflows for future returns occurs because current inflows predict future inflows, and future inflows drive up prices.

8. We find little support for the Brennan and Cao hypothesis that emerging market inflows are the result of a cumulative informational disadvantage on the part of international investors about local country conditions. The common factor of inflows within a region seems to positively predict prices and to move contemporaneously with prices. On the other hand, the country-specific factor of flows has little price impact and predicts future returns poorly.

9. Our explanation for the co-movement of returns and flows is that flows contain information about future value. Emerging market prices do not fully appreciate the implication of an increase in inflow for future value, so cross-border trades tend to be “informed”. However, price pressure in these markets is substantial, so that a cessation of inflow can reduce emerging market prices. This hypothesis is unable to explain the home bias in international portfolio allocations, but it better fits the facts of flows and returns. fast payday loan