The Role of Domestic and Foreign Sentiment for Cross-Border Portfolio Flows

Abstract

We show that sentiment influences the demand for foreign stocks, as identified by international portfolio flows between investors in the United States and investors in 44 other countries. We document two channels through which sentiment affects flows. First, inflows are higher to countries with higher sentiment. Second, higher sentiment in a given country is associated with lower outflows from that country to bilateral trade partners, suggesting that sentiment in one country can have spillover effects on demand for assets in other countries. The combined sentiment effects are associated with economically meaningful implications for net flows. Finally, we consider country closed-end funds and find evidence of pricing effects of sentiment.

Keywords: sentiment, foreign sentiment, international finance, capital flows

JEL Classification: F30, F32, G11, G14, G15