What Flows Around Comes Around: Mean Reversion and Portfolio Flows

43 Pages Posted: 25 Apr 2019 Last revised: 19 Jun 2019

See all articles by Florian Mair

Florian Mair

Vienna University of Economics and Business

Alexander Thoma

University of Zurich - Department of Banking and Finance

Date Written: March 27, 2019

Abstract

This paper investigates mean reversion properties of real effective exchange rates (REERs) using a semi-parametric quantile autoregression approach. This method accounts for non-normality and captures asymmetric and dynamic adjustments towards the REER's long run equilibrium, conditional on the size of the shock to the REER. Due to our tests' nonstandard limiting distribution, we apply a resampling procedure for robust inference. Using a sample of 29 countries over the period 1980-2017, we indeed show that the REER features non-linear mean-reverting tendencies following large shocks. The REER adjusts dynamically and asymmetrically towards its long run equilibrium, conditional on the size of the shock. We find half lives of less than one year in some cases for the most extreme quantiles. Additionally, panel regressions indicate that this behavior can be explained by portfolio flows. Large deviations in the REER from its long run mean are followed by debt portfolio flows from international investors. These flows are associated with an appreciation in the REER, conditional on the level of deviation and the shocks incurred, leading to faster mean reversion in REERs. In the most extreme quantile, the flows move the REER back towards its mean by 1.78% per month.

Keywords: Currency value, real effective exchange rates, purchasing power parity, currency returns, forward premium puzzle, uncovered interest rate parity, portfolio flows, balance of payments

JEL Classification: F31, F32, E01, E44, E71, G10, G11, G15, G40

Suggested Citation

Mair, Florian and Thoma, Alexander, What Flows Around Comes Around: Mean Reversion and Portfolio Flows (March 27, 2019). Available at SSRN: https://ssrn.com/abstract=3359574 or http://dx.doi.org/10.2139/ssrn.3359574

Florian Mair

Vienna University of Economics and Business ( email )

Welthandelsplatz 1
Vienna, Wien 1020
Austria

Alexander Thoma (Contact Author)

University of Zurich - Department of Banking and Finance ( email )

Sch├Ânberggasse 1
Z├╝rich, 8001
Switzerland

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