Cross-border capital flows and the behavior of the market returns

Abstract

I examine net purchases of securities between the U.S. and four economic zones (World, Europe, Asia, and Pacific countries). For cross-border investment flows, U.S. stock returns Granger-cause foreign investment flows into the U.S. I find that the international financial market is considerably integrated. U.S. Treasury and corporate bond market returns do not increase the ability to forecast future foreign investment flows into the corresponding U.S markets. This observation suggests that foreign flows into the stock market are primarily driven by stock performance, whereas other determinants, besides simple mean-variance trade- off, are greatly considered for cross-border investment in other market sectors. Investors' strategies for portfolio allocation also differ substantially across regional zones. The explanation of investment flows is more likely to rest in traditional macroeconomic performance measures (GNP growth differentials, inflation differentials, real return differentials, etc.) or conventional international investment variables (e.g., exchange rate risk, balance of trade).