Indeed, by identifying the regional factor in flows we can determine whether the remaining idiosyncratic components account for the contemporaneous correlation of returns and flows. If, once the regional factor of flows is removed, there is no remaining contemporaneous correlation between returns and inflows, it suggests that international demand shocks, not shocks to information, better explain the correlation.
Do flows move prices too much, so that they predict returns negatively, or too little, so that they predict returns positively? Here the evidence from international flows is scarce. Clark and Berko (1996) examine Mexico during the late 1980s through the crisis in 1993. They find that unexpected inflows of 1% of the market’s capitalization drive prices up by 13%. In spite of the large effect, there is no evidence of non-contemporaneous correlation: the price change is permanent and there is no further predictability.
There is, of course, a much larger empirical literature examining how the composition of investors impacts prices. Warther (1995) investigates aggregate monthly inflows into mutual funds and the impact they have on stock and bond prices. He finds unexpected inflows (i.e., the shock to inflows beyond that predicted by past inflows) are correlated with contemporaneous returns, but that expected inflows are not. His data suggest that a 1% increase in mutual fund equity assets results in a 5.7% increase in stock prices. He also finds no evidence that such price increases are transitory. A second strand of literature looks at inflows into US mutual funds. Here again there is little evidence of non-contemporaneous correlation between flows and returns. online payday loan
Finally, there is considerable evidence in other markets that investor flows drive prices. For example, Froot and O’Connell (1997) study catastrophe risk prices and find that fluctuations in investor demand, given the supply of insurable risks, drives prices away from estimates of fair value. Gompers and Lerner (1997) provide similar evidence for private equity. It is worth noting that even if overshooting of prices in response to flows is present, such effects are difficult to discern in short time series samples such as the one used in this paper.