Cross-Border Investment and the Decline of Exchange Rate Volatility: Implications for Euro Area Bilateral Investments

34 Pages Posted: 5 May 2021 Last revised: 18 Aug 2022

See all articles by Maela Giofré

Maela Giofré

University of Turin - Department of Economics and Statistics; CeRP-CCA; Netspar

Oleksandra Sokolenko

University of Turin, Department of Economics and Statistics, Students

Date Written: April 30, 2021

Abstract

Exchange rate volatility has undergone a secular decline since the collapse of the Bretton Woods system. We conjecture that this phenomenon may have led to a generalized decreased need for risk exchange hedging in financial markets. Indeed, we find that the negative association between bilateral foreign portfolio investments and the volatility of the exchange rate has markedly weakened over time. This finding, which is particularly significant for large countries and in the post-crisis period, can also help explain the decline in bilateral investments among EMU member countries. We observe, in fact, that, after 2012, the distinctive fall of Euro-area bilateral equity investments is significantly explained by the global declining effect of exchange rate volatility on financial markets. A lower exchange rate volatility, associated with the ensuing generalized reduction in the perceived exchange rate risk, may have posed a challenge to the economic relevance of the full exchange risk hedging system represented by the common currency area, and hence to the attractiveness of reciprocal investments.

Keywords: exchange rate volatility; common currency; Euro area; foreign portfolio investment

JEL Classification: F21, F30, F36, G11, G15

Suggested Citation

Giofré, Maela and Sokolenko, Oleksandra, Cross-Border Investment and the Decline of Exchange Rate Volatility: Implications for Euro Area Bilateral Investments (April 30, 2021). Available at SSRN: https://ssrn.com/abstract=3837242 or http://dx.doi.org/10.2139/ssrn.3837242

Maela Giofré (Contact Author)

University of Turin - Department of Economics and Statistics ( email )

Lungo Dora Siena 100/A
Torino, Turin - Piedmont 10153
Italy

CeRP-CCA ( email )

Via Real Collegio 30
Moncalieri (TO), Turin 10024
Italy

Netspar ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Oleksandra Sokolenko

University of Turin, Department of Economics and Statistics, Students ( email )

Torino
Italy

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