Shorting the Dollar When Global Stock Markets Roar: The Equity Hedging Channel of Exchange Rate Determination

UNSPECIFIED (2022): Shorting the Dollar When Global Stock Markets Roar: The Equity Hedging Channel of Exchange Rate Determination.

Abstract

We document a new channel of exchange rate determination by examining the impact of global equity market shocks on the collective hedging of foreign exchange (FX) risk by large institutional investors (IIs). Using novel daily data on FX forward flows of Israeli IIs, we investigate the causality between global equity shocks, hedging demands of IIs, and the exchange rate. We find that a one standard deviation innovation to the MSCI ACWI index leads to significant and persistent selling of dollar forwards by IIs, likely as a hedge against increased FX exposure. As a result, both the USD/NIS spot and forward rates experience a significant and persistent decline following the MSCI innovation.

• Item Type: MPRA Paper
• Language: English
• Keywords: Equity Hedging Channel; Foreign Currency Forward Flows; Order Flow; Limits of Arbitrage; FX Dealers; Forward Exchange Rate; Spot Exchange Rate; Global Stock Prices; Institutional Investors; Bayesian Local Projections. Spot Exchange Rate; Global Stock Prices; Institutional Investors; Bayesian Local Projections.
• Subjects: E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy; F - International Economics > F3 - International Finance; F - International Economics > F3 - International Finance > F31 - Foreign Exchange; G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets

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