Template-Type: ReDIF-Paper 1.0
Author-Name: Ahmed Ahmed
Author-X-Name-First: Ahmed
Author-X-Name-Last: Ahmed
Author-Name: Boris Hofmann
Author-X-Name-First: Boris
Author-X-Name-Last: Hofmann
Author-Name: Martin Schmitz
Author-X-Name-First: Martin
Author-X-Name-Last: Schmitz
Title: Foreign institutional investors, monetary policy, and reaching for yield
Abstract: This paper uses security-level data of euro area investment funds' bond holdings to analyze their reaching for yield in the US dollar bond market. We find that they rebalance their US dollar bond portfolios toward higher yielding, riskier bonds when US monetary policy tightens, reflecting the effects of foreign exchange hedging. The effect is driven by the practice of hedging currency risk through rolling short-term hedging contracts. This gives rise to an erosion of the hedged yield earned on US dollar bonds when US monetary policy tightens and hedging costs increase, inducing reaching for yield in order to bolster portfolio returns. The hedging channel of monetary transmission is diametrically opposed to the classical risk-taking channel operating through US dollar-based investors, where a monetary tightening is associated with less reaching for yield. We further find that the US dollar bond purchases by euro area investment funds induced by their reaching for yield have meaningful effects on bond prices, implying that they affect conditions in the US dollar bond market.
Creation-Date: 2023-12
File-URL: https://www.bis.org/publ/work1153.pdf
File-Format: Application/pdf
File-Function: Full PDF document
File-URL: https://www.bis.org/publ/work1153.htm
File-Format: text/html
Number: 1153
Keywords: monetary policy, foreign institutional investors, FX hedging, US dollar bond market
Classification-JEL: E43, E52, G11, G12, G15, G23
Handle: RePEc:bis:biswps:1153