Joseph J. French

Volatility and foreign equity flows: evidence from the Philippines

Purpose - The purpose of this paper is to dissect the dynamic linkages between foreign equity flows, exchange rates and equity returns in the Philippines. Design/methodology/approach - Using a parsimonious SVARX-GARCH model and unique daily equity flow data, this research models the relationship between net equity flows, conditional variance of stock returns and conditional variance of exchange rates. Findings - The authors find several noteworthy results, which are unique to this study and several results that confirm existing literature. Much of existing literature on foreign equity flows into emerging economies find that foreign equity investors are trend chasers and equity flows are auto correlated. The authors confirm these finding in the Philippines and document two new and important findings. First, it was found that unexpected increases in foreign equity flows to the Philippines increases the conditional volatility of the Filipino stock market significantly over the next two weeks of trading. The second major finding is that unexpected shocks to foreign equity flows sharply increases the conditional variance of the USD/PHP exchange rate over the next two to three weeks of trading. Practical implications - Taken together, the results indicate that foreign equity investment, while providing many benefits for small open economies such as the Philippines, does in the short run increase the conditional variance of both the equity market and exchange rates. Policy makers must weigh the benefits of increased risk sharing and the potential for lower costs of capital with the short-run potential for increase swings in asset prices. Originality/value - This paper is one of the only studies of its kind to test the impact of foreign equity flows on the conditional volatility of returns and exchange rates.

A note on US institutional equity flows to Brazil

Purpose - The purpose of this research is to understand the long-run dynamics between returns, commodity prices, volatility, and US equity investment into Brazil. This research is prompted by the rapid increase in foreign equity investment into Brazil. Design/methodology/approach - To address long-run dynamic nature of the variables, multivariate autoregressive model is fitted for the period of January 1998 to May 2008. To achieve identification of this model, restrictions are imposed based on underlying financial theory and the nature of the data. Findings - The paper finds consistent with a long literature, that US institutional equity investment is forecasted by past returns on the Brazilian stock index (BOVESPA). The paper also documents the important role of commodity prices in forecasting US equity flows to Brazil, a variable that has not been considered in much of existing literature. Finally, the paper uncovers a strong relationship between US equity flows to Brazil and measures of risk. The paper documents that an unexpected shock to US equity flows increases the volatility of the Brazilian equity market beyond what could be predicted by other variables in the system. The strong joint dynamics among US portfolio equity flows and the risk and return of the Brazilian equity market demonstrates the need for policy makers in Brazil to monitor short-term portfolio flows. Originality/value - There is a broad literature on the dynamics of US investment in emerging and developed markets but very little work focuses directly on Brazil. Additionally, this work is one of the first to explicitly consider the role of commodity prices on the dynamics of foreign equity flows to resource rich nations.

Decomposing the Relationship Between Human Capital and GDP: An Empirical Analysis of Bangladesh

This paper dissects the relationship between human capital stock and real GDP per capita in Bangladesh using VEC and VAR techniques. Results show that GDP granger causes aggregate human capital stock. This paper constructs a measure of Bangladeshs human capital stock for the period of 1973-2004 using the perpetual inventory method. Innovations in secondary and higher secondary education are found to have the greatest short to medium-term impact on the countrys real GDP. Consistently this research also finds evidence that the variance of the human capital sequence is strongly influenced by shocks to the GDP sequence, whereas the evolution of GDP over the medium term is relatively unaffected by shocks to aggregate human capital stock. These results show that increases in human capital tend to follow income. The findings of this research suggest that secondary and higher secondary education should be emphasized by Bangladesh.

Returns or valuation? Foreign equity investment in the United States

Purpose - The purpose of this paper is twofold; first, to understand the long-run dynamics between returns, valuation measures and foreign investment in the USA; second, to determine if these dynamics change following financial market upheaval. Design/methodology/approach - To address long-run dynamic nature of the variables, multivariate autoregressive models are fitted for the period of January 1977 to November 2008. To gain additional insight about the nature of equity flows its dynamics are analyzed over the periods containing the 1987 stock market crash and the two major asset bubbles, e.g. internet bubble and the housing bubble. Findings - The authors find that foreign institutional equity flows are more sensitive to innovations in valuation measures than innovations to excess US market returns; and that foreign investors increase their purchases of US market capitalization following a positive innovation to measures of valuation. The results imply that the behavior of foreign institutional investors are not described by “return chasing” alone. The authors further find that in times of increased uncertainty the joint dynamics between foreign equity flows and valuation measures decouples. Finally consistent with existing literature it was found that equity flows to the USA are autocorrelated. Originality/value - There is a broad literature on the dynamics of US investment in emerging and developed markets, but very little (if any) research that analyzes the dynamics of equity flows to the US, returns, and measures of valuation. Furthermore, the literature on the behavior of equity flows surrounding financial crises is scant, particularly for developed markets.

Disentangling the Relationship between Liquidity and Returns in Latin America

We dissect the impact of liquidity on returns of Latin American firms using a detailed data set of firm characteristics over various market cycles. We find that firm-level liquidity (illiquidity) is positively (negatively) associated with returns. Further analysis reveals that global illiquidity and endogenously determined crisis periods are negatively associated with returns. Our results are in contrast to the majority of the literature on developed markets and indicate that liquidity is less of an important risk factor in Latin America. Our results suggest that improvements in firm-level liquidity will enhance returns and reduce the vulnerability of returns to global illiquidity.