Macroeconomic Fundamentals and Net Portfolio Investment Between Developed Regions*

Abstract

Our paper investigates how macroeconomic fundamentals correlate with net capital inflows in the US. Understanding the factors associated with capital flows helps policy makers to predict future capital flows and analyse the international implications of domestic macroeconomic policy. Yet the theoretical relationship between net capital inflows and relative economic conditions is ambiguous. Using quarterly data from 1988 to 2003, we analyse the relation between a set of relative macroeconomic variables and net purchases of US stocks and bonds from Western Europe, Canada, Japan and Australia. We find that relative output growth is uncorrelated with net US investment for all regions. However, other macroeconomic factors matter; for example, an increase in US interest rates relative to European interest rates is associated with an increase in net portfolio investment from Europe. The linkages between à We wish to thank Tomas Dvorak, International Finance 8:2, 2005: pp. 303-327 macroeconomic factors and net foreign investment in the US are strongest for Western Europe, implying that information costs, home bias and other capital frictions are less relevant for US-Europe flows compared with capital flows between the US and the other three source regions. Lastly, stock purchases are more correlated with macroeconomic fundamentals than bonds, a striking finding suggesting that equity traders are more likely than bond traders to change their net asset holdings as a result of a macroeconomic event.

Information Diffusion among International Fund Managers: Multicountry Evidence

“…These portfolio trends are consistent with historical US Treasury data. For example, Simpson, Tomljanovich, and Georgiev (2005) report that Western Europe, Canada, Japan, and Australia were sources of more than 64% of US‐bound portfolio flows during the period 1988‐2003. Our data are broadly consistent with these trends.…”

International integration from capital flow and regional trade agreement perspectives

“…For the second motivation of capital flow, if foreign investors benefit from higher returns in the host country's capital market, this benefit can translate in to a lower cost of capital for the recipient country. Past research showed that macroeconomic fundamentals mattered in determining stock return indexes and their volatility (Elhossiny 2005;Simpson, Tomljanovich et al 2005). Moreover, both economic and political stabilities were important determinant of a country's creditworthiness and credit rating, which in turn affected the country's access to international portfolio capital and the cost of capital.…”