Portfolio Rebalancing in Times of Stress

Abstract

This paper investigates time variation in the dynamics of international portfolio equity flows. We extend the empirical model of Hau and Rey (2004) by embedding a two-state Markov regime-switching model into the structural VAR. The model is estimated using monthly data, 1995-2015, on equity returns, exchange rate returns and equity flows between the United States and advanced and emerging economies. We find that the data are consistent with portfolio rebalancing. The estimated states match periods of low and high financial stress. Our main result is that for equity flows between the United States and emerging markets, the rebalancing dynamics differ between episodes of high and low levels of financial stress. A switch from the low to the high-stress regime is associated with capital outflows from emerging markets. Once in the high stress regime, the response of capital flows to exchange rate shocks is smaller than in normal (low stress) periods.

Moderating Influence of Portfolio Rebalancing on the Relationship between Asset Allocation and Financial Performance of Pension Funds in Kenya

“…Bams, Schotman & Tyagi (2016) state that pension funds actively rebalance their portfolio to counteract the impact of return on their portfolios significantly more than the rebalancing estimated for households. Fischer et al (2021) posits that when price shocks cause the portfolio weights to deviate from their optimal risk-return maximizing values, investors rebalance their portfolios. Huss & Maloney (2017) aver that well-managed dynamic rebalancing processes may lead to more predictable risk characteristics, while seemingly passive buy-and-hold portfolios may have the most variable and least predictable risk outcomes.…”