International portfolio rebalancing and exchange rate fluctuations in Thailand

August 2009

Abstract

We present empirical evidence for Thailand regarding the linkages between exchange rates, equity prices and capital flows. We find that the linkages are broadly consistent with the recent equilibrium model with imperfect foreign exchange trading by Hau and Rey (2006) in which exchange rates, equity prices and capital flows are jointly determined. We present market-wide empirical evidence suggesting that foreign investors only imperfectly hedge foreign exchange risk. The price and capital flow dynamics found for Thailand are consistent with those for more developed economies presented. We find that higher returns in the Thai equity market relative to foreign equity markets are clearly associated with Thai baht depreciation. We also find that net capital flows of nonresident investors are clearly associated with Thai baht appreciation. Our results are based on new data with a daily-frequency for both returns and capital flows undertaken by nonresident investors in the equity market of Thailand in 2005 and 2006.