Uncovered Equity Parity and Rebalancing in International Portfolios

41 Pages Posted: 31 May 2017

See all articles by Stephanie E. Curcuru

Stephanie E. Curcuru

Board of Governors of the Federal Reserve System

Charles P. Thomas

Thomas & Son Analytics

Francis E. Warnock

University of Virginia - Darden Business School; National Bureau of Economic Research (NBER)

Jon Wongswan

Phatra Securities

Multiple version iconThere are 2 versions of this paper

Date Written: 2014-05-15

Abstract

Portfolio rebalancing is a key driver of the Uncovered Equity Parity (UEP) condition. According to UEP, when foreign equity holdings outperform domestic holdings, domestic investors are exposed to higher exchange rate exposure and hence repatriate some of the foreign equity to decrease their exchange rate risk. By doing so, foreign currency is sold, leading to foreign currency depreciation. We examine the relationship between U.S. investors' portfolio reallocations and returns and find some evidence consistent with UEP: Portfolio shifts are related to past returns in the underlying equity markets. But we argue that a motive other than reducing currency risk exposure is likely behind this rebalancing. In particular, U.S. investors may be exploiting mean reversion in underlying equity markets, rebalancing away from equity markets that recently performed well and moving into equity markets market just prior to relatively strong performance. Such behavior suggests tactical reallocations to increase returns rather than reduce risk.

Keywords: Exchange rate determination, international returns, equity portfolios

Suggested Citation

Curcuru, Stephanie E. and Thomas, Charles P. and Warnock, Francis E. and Wongswan, Jon, Uncovered Equity Parity and Rebalancing in International Portfolios (2014-05-15). FRB International Finance Discussion Paper No. 1103. Available at SSRN: https://ssrn.com/abstract=2976797

Stephanie E. Curcuru (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th and C Streets, NW
Washington, DC 20551
United States

Charles P. Thomas

Thomas & Son Analytics ( email )

5409 Center St
Chevy Chase, MD 20815
United States
2022075834 (Phone)

Francis E. Warnock

University of Virginia - Darden Business School ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
434-924-6076 (Phone)

HOME PAGE: http://faculty.darden.virginia.edu/warnockf/index.htm

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138-5398

Jon Wongswan

Phatra Securities ( email )

11F Muang Thai-Phatra Office Tower 1
252/6 Ratchadapisek Road
Bangkok, 10400
Thailand

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