Beyond Capital Flows: The Hidden Role of Valuation Effects

Abstract

This study investigates the impacts of U.S. monetary policy shocks on international valuation effects. We construct a novel dataset of financial effective exchange rates (FEER) covering 44 countries and decompose valuation effects into price effects and exchange rate effects for equities and bonds, respectively. First, we show that U.S. monetary policy shocks have substantial impacts on valuation effects. Net valuation changes decline significantly in the short run, mainly driven by fluctuations in exchange rates. However, in the long run, the valuation effects become insignificant as exchange rate effects and price effects offset each other. Second, both price and exchange rate valuation effects differ between advanced economies and emerging market economies due to differences in the composition of their international investment positions. Lastly, U.S. monetary tightening increases equity prices but decreases bond prices.

Keywords: Monetary policy, Valuation effects, Structural VAR, Financial Effective Exchange Rate, International Investment Position