Global Portfolio Rebalancing under the Microscope”, Working Paper No

The dramatic increase in gross stock of foreign assets and liability has revived interest in the portfolio balance theory of international investment. Evidence on the validity of this theory has always been scarce and inconclusive. The current paper derives testable empirical implications from microeconomic foundations, which we confront with a new comprehensive data set on the stock allocations of approximately 6,500 international equity funds domiciled in four different cur-rency areas. The disaggregated data structure allows us to examine whether foreign exchange and equity risk measures trigger the predicted rebalancing behavior at the fund and stock level. The data provide strong support for portfolio rebalancing behavior aimed at reducing both exchange rate and equity risk exposure. Sylvain Champonnois provided excellent research assistance. We are very grateful to the Fondation Banque de France and especially Henri Pagès for financial support and feedback. We also benefited greatly from comments by Paolo Mauro, Ja