Funds who deviated more from benchmark indices tended to have excess returns. By contrast, when using historical returns as proxies for expected returns, the model does poorly compared to simple benchmark indices. In a study of closed-end country funds, Frankel and Schmukler examine how the Mexican crisis was transmitted to other markets studying fund net asset values and fund prices, which are quoted in local stock markets and New York, respectively. While changes in net asset values in Mexico are transmitted directly to other Latin American markets, for Asia, spillovers appear to occur through fund prices in New York.
This per se does not provide evidence for any particular portfolio channel of contagion, but it is consistent with the notion that international investors holding assets in New York aimed at a readjustment in their overall portfolios in response to the shock. In a related vein, Boyer, Kumanagai, and Yuan separate emerging market stocks into two categories, those that are eligible for purchase by foreigners and those that are not, and compare the degree to which accessible and inaccessible stock index returns co-move with crisis country index returns.
They find higher comovement among accessible stock returns, suggesting that crises spread through the asset holdings of international investors rather than through changes in fundamentals. Jotikasthira, Lundblad, and Ramadorai , using data from developed-country-domiciled mutual and hedge funds, find that inflows and outflows experienced by these funds translate into significant changes in their portfolio allocations in emerging markets. They also find that these portfolio shifts substantially impact emerging market equity returns, and are associated with increases in co-movement between emerging and developed markets.
Kaminsky, Lyons, and Schmukler , examining quarterly data on 13 Latin American mutual funds, find that they sell buy assets from one country when asset prices fall rise in another.
In the case of the Thai crisis, it outperforms trade and bank linkages as an explanatory variable, while for the Russian and Brazil crises, trade linkages seem to be at least as important in explaining the extent to which other countries were affected Figure 3. Source: Broner, Gelos, and Reinhart In sum, there is empirical evidence supporting the notion that benchmark-following and portfolio rebalancing by fund managers plays a role in transmitting shocks across financial markets, even in the absence of common macroeconomic fundamentals.
It has frequently been argued that increasing transparency defined as the availability and reliability of information can both be beneficial in attracting investment while helping to avoid excessive capital flow volatility see, for example, IMF , Frenkel and Menkhoff, , and Gai, Stulz develops an equilibrium model in which costs associated with holding foreign assets can induce investors to hold fewer foreign assets. The literature explicitly modeling the link between transparency of emerging markets and volatility is still limited. Models like the one of Calvo and Mendoza suggest that information asymmetries can play an important role in shaping the degree of volatility of foreign investor flows.
More generally, models of herding that rely on informational cascades suggest that herding should be less prevalent in more transparent markets. Pasquariello develops a framework in which lower information heterogeneity i. There is evidence that foreign investors indeed tend to avoid less transparent markets and assets. Using security-level data on U. Giannetti and Koskinen report that mutual funds invest more in countries with better investor protection.
What Drives Capital Flows to Emerging Markets? A Survey of the Empirical Literature
Ferreira and Matos show that institutions reveal a preference for stocks of countries with strong disclosure standards. Gelos and Wei , using various measures of government and corporate opacity, also find that emerging market mutual funds prefer to invest in more transparent countries Figure 5. Didier points out that differences in the mandates of global versus specialized mutual funds imply different costs and benefits in gathering and processing information and finds that global funds tend to hold more assets from firms that are less prone to informational asymmetries.
Didier, Rigobon, and Schmukler study a comprehensive set of data on U. The authors, however, argue that the pattern is not explained by a lack of information. There is also some evidence that more transparency may reduce the volatility of mutual fund flows. Gelos and Wei report that during crises, funds tend to flow more from less transparent countries and that herding is more pronounced in less transparent markets.
Gande and Parsley , using the same data on emerging market funds, find that less corrupt countries are less vulnerable to downgrades by rating agencies, as measured by mutual fund outflows. What do the results on opacity imply for the question of whether foreign funds are better or worse informed than local investors in emerging markets? In a study of Mexican corporate news announcements, Bhattacharya, Daouk, Jorgenson, and Kehr provide evidence consistent with this hypothesis.
Similarly, Frankel and Schmukler show that before the crisis, Mexican investors turned pessimistic before foreigners. The evidence presented in Gelos and Wei indicates that foreign investors seem to——other things equal——prefer more transparent markets because they fear being taking advantage of by insiders.
Cross-Border Capital Flows, Fluctuations and Growth
Using transaction data from the Jakarta Stock Exchange, Dvorak finds evidence indicating that domestic investors have an informational advantage over foreigners, including that foreign investors systematically buy at a higher and sell at lower intra-day prices than domestic investors. Source: Didier, Rigobon and Schmukler Figure shows the total number of stock holdings for all U. Countries are sorted according to their average ratio in the period. Countries are divided into five groups quintiles and the average and maximum values for each quintile are reported.
The data for the total number of listed stocks come from the Global Financial Database. Various studies, however, suggest that foreign funds do well in emerging markets. Finance practitioners often use mutual fund flows to help predict returns in emerging markets see for example, Deutsche Bank, Froot and Ramadorai , examining the response of prices and net asset value returns to cross-border flows, find evidence consistent with the notion that foreign investors have better information than local investors. Huij and Post report that emerging market funds generally display better performance than US funds, and Polwitoon and Tawatnuntachai provide evidence for good performance of emerging market bond funds.
Similarly, Rodriguez argues that Latin American fund managers demonstrate forecasting ability as evidenced by a positive and statistically significant attribution return. These findings could be reconciled if foreigners were at an informational disadvantage about domestic conditions thereby avoiding opaque markets but at an advantage regarding global factors, as argued in Albuquerque, Bauer, and Schneider Understanding the behavior of international investors is key for informing the debate about the optimal response to international capital flows and about reforms to the international financial architecture.
In this context, recent research on the behavior of international mutual funds at the micro level has improved our understanding of the drivers of international portfolio flows and the mechanisms behind the transmission of financial shocks across countries. Among the lessons learned are: Overall, the behavior of international mutual funds is complex and overly simplistic characterizations are misleading. International funds tend to avoid opaque markets and assets. This behavior becomes more pronounced during volatile times, and funds tend to flee less transparent countries during crises.
The fact that emerging market mutual funds find it more difficult to overcome local opacity does not imply that, overall, they are at an informational disadvantage: the evidence tends to suggest that these funds perform relatively well, possibly because they are better informed about global factors.
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Portfolio rebalancing mechanisms are clearly important in explaining contagion patterns, even in the absence of common macroeconomic fundamentals. Volatility of capital flows is to some extent driven by investors investing in emerging market funds rather than behavior at the level of the fund manager. Momentum trading is present among mutual funds. There is also some evidence for herding. However, its quantitative importance is not fully clear. Clearly, funds do not all move together in the same ways. Most studies suggest that portfolio changes by emerging market equity funds have an impact on market returns.
From a surveillance point of view, this implies that monitoring the exposures of large investors at a micro level is important to be able to predict vulnerabilities. From a policy perspective, the evidence supports the notion that increasing transparency— i. Much more research is needed to understand the increasingly complex interaction between different types of international investors in emerging markets.
What Drives Capital Flows to Emerging Markets? A Survey of the Empirical Literature
While mutual funds represent an important group of investors, pension funds and hedge funds have been allocating growing shares of their assets in emerging markets, a trend that is unlikely to wane soon. Little is understood so far about the interplay between the different incentives and constraints faced by the managers of these funds, and filling this gap is an important challenge for further research.
Albuquerque Rui H. Ausubel Lawrence M.
Context | Financial System Inquiry
Dissertation University of California San Diego. Boyer Brian H. Brennan Michael. Calvo Guillermo A.
Chan Louis K. Washington : International Monetary Fund. Curcuru Stephanie E. Charles P. Thomas Francis E. Daniel Naveen D. DeLong J.