Currency Returns, Institutional Investor Flows, and Exchange Rate Fundamentals

49 Pages Posted: 15 May 2012 Last revised: 14 Nov 2022

See all articles by Kenneth Froot

Kenneth Froot

Harvard University Graduate School of Business; National Bureau of Economic Research (NBER)

Tarun Ramadorai

Imperial College London; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Multiple version iconThere are 3 versions of this paper

Date Written: August 2002

Abstract

We explore the interaction between exchange rates, institutional investor currency flows and exchange-rate fundamentals. We find that these flows are highly correlated with contemporaneous and lagged exchange rate changes, and that they carry information for future excess currency returns. This information, however, is not strongly linked to future fundamentals. Flows are important in understanding transitory elements of excess returns, which include short-run underreaction and long-run overreaction. However, flows have a zero or negative correlation with permanent components of excess returns. We find that measured fundamentals - not flows - seem important in understanding permanent elements of excess returns. We conclude that investor flows are important for understanding deviations of exchange rates from fundamentals, but not for understanding the long-run currency values.

Suggested Citation

Froot, Kenneth and Ramadorai, Tarun, Currency Returns, Institutional Investor Flows, and Exchange Rate Fundamentals (August 2002). NBER Working Paper No. w9101, Available at SSRN: https://ssrn.com/abstract=2059846

Kenneth Froot (Contact Author)

Harvard University Graduate School of Business ( email )

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Tarun Ramadorai

Imperial College London ( email )

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Centre for Economic Policy Research (CEPR) ( email )

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