International Equity Flows and Returns: A Quantitative Equilibrium Approach

This paper considers 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 U.S. investors' international equity trades: ("i") trading by U.S. investors occurs in waves of" simultaneous "buying and selling; ("ii") U.S. investors build and unwind foreign equity positions gradually; and ("iii") U.S. 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. Copyright 2007 Federal Reserve Bank of Minneapolis.