THE PORTFOLIO FLOWS: The Interaction Between Flows and Returns 2

Table 5 presents the decomposition of the quarterly covariance of flows and equity returns at the regional level. The first column reports the actual CKR-statistic with к set equal to 60 (quarterly decomposition.) For the purposes of inference, the variance of the СКЯ-statistic and its components is estimated from the heteroscedasticity-consistent variances of the daily p estimates add comment.

The first point to note about the tables is that they show clearly the benefit of using daily data instead of monthly or quarterly data. As we can see from Table 5, Panel B, contemporaneous covariance, accounts for at most 13% of measured quarterly covariance. We can see that only a third of the quarterly covariance between flows and equity returns can be attributed to the window period from -5 days to +5 days.

Table 5 also shows the decomposition of the lag and lead effects. For both developed markets and emerging markets, it is clear that most of the CKK-statistic is due to component (a). As mentioned earlier, the size and significance of component (a) tell a simple story of investor “trend chasing” behavior. In other words, positive local stock market returns result in future local inflows.

For the world overall, there is little predictability of future returns from current flows. However, the world-wide data obscure an important difference between developed and emerging markets. If we concentrate on developed markets only, Table 5 shows evidence that flows predict future equity returns negatively. This is particularly true at longer horizons. Such a finding might be evidence of overreaction or price pressure. Emerging markets, on the other hand, indicate that flows predict equity returns positively, and seem to do so at short as well as long horizons. Over most time horizons the coefficients are statistically positive. Once again the covariance grows over time, so that an inflow today is associated with a tendency toward positive emerging market returns over many days into the future. This is consistent with the view that international investors may have better marginal information than locals have in emerging markets.

These findings seem inconsistent with the Brennan and Cao view that the positive covariance between emerging market returns and inflow is attributable to international investors’ information disadvantage. If local, not global, information shocks drive emerging market returns, then we would not expect to see a large, regional flow component, nor would we expect it to covary strongly with returns, as the top panel of Table 5 suggests it does. Moreover, the use of the regional factor (of flows) appears to suggest international investors have a marginal informational advantage.