DP5159 | International Equity Flows and Returns: A Quantitative Equilibrium Approach

Publication Date

23/08/2005

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Abstract

This paper reconsiders the role of foreign investors in developed country equity markets. It presents a quantitative model of trading that is built around two new assumptions about investor sophistication: (i) both the foreign and domestic populations contain investors with superior information sets; and (ii) these knowledgeable investors have access to both public equity markets and private investment opportunities. The model delivers a unified explanation for three stylized facts about US investors? international equity trades: (i) trading by US investors occurs in waves of simultaneous buying and selling; (ii) US investors build and unwind foreign equity positions gradually; and (iii) US investors increase their market share in a country when stock prices there have recently been rising. The results suggest that heterogeneity within the foreign investor population is much more important than heterogeneity of investors across countries.