How do international portfolio flows behave? Do flows affect asset and currency returns? Are emerging market stock prices and exchange rates particularly vulnerable to such flows? These questions have been of perennial interest to investors, economists, and policy makers for as long as capital has crossed borders. They are posed with greater urgency during times of financial upheaval (e.g. the 1997-1998 Asian and 1994-1995 Mexican currency crises.) Frequently, the answers to these questions cast international investors in a poor light. It is argued that foreign outflows lead to prices that overreact and to contagion. An opposing view—espoused most often by economists—is that trading is merely the process by which information is incorporated into asset prices. International investors do not create or exacerbate crises; their trading behavior simply reflects their assessment of underlying fundamentals.
While there are plenty of strongly held views, there is surprisingly little information on the behavior of international portfolio flows and their relationship with local currency and asset returns. Indeed, what little information there is on aggregate investor purchases in major capital markets comes from quarterly, or at best monthly, data. For example, Tesar and Werner (1993, 1995), Bohn and Tesar (1996), and Brennan and Cao (1997) examine estimates of aggregate international portfolio flows. They find evidence of positive, contemporaneous correlation between inflows and returns. But the low frequency of previously available data is a severe limitation given the poor statistical precision it permits.
Partly as a result of this, little has thus far been said about international flows (e.g., is there herding or trend-following), or about the effects international flows have on local asset returns.
In this paper, we exploit a new and potentially superior source of flow data to help answer these questions. The data come from State Street Bank & Trust, one of the world’s largest custodian banks. Custodians keep detailed records of worldwide securities holdings, trades, and transaction settlements. State Street’s clients are predominantly large institutional investment pools from developed countries, including pensions, endowments, mutual funds and governments. They can be thought of as a large sample of sophisticated international investors. State Street’s aggregated, international, settlement data provide us with net and gross international trades on a daily basis, by country, from mid-1994 through mid-1998. We are therefore able to track daily purchases into, and sales out of, 46 countries.