Purpose – The purpose of this paper is twofold; first, to understand the long‐run dynamics between returns, valuation measures and foreign investment in the USA; second, to determine if these dynamics change following financial market upheaval. Design/methodology/approach – To address long‐run dynamic nature of the variables, multivariate autoregressive models are fitted for the period of January 1977 to November 2008. To gain additional insight about the nature of equity flows its dynamics are analyzed over the periods containing the 1987 stock market crash and the two major asset bubbles, e.g. internet bubble and the housing bubble. Findings – The authors find that foreign institutional equity flows are more sensitive to innovations in valuation measures than innovations to excess US market returns; and that foreign investors increase their purchases of US market capitalization following a positive innovation to measures of valuation. The results imply that the behavior of foreign institutional investors are not described by “return chasing” alone. The authors further find that in times of increased uncertainty the joint dynamics between foreign equity flows and valuation measures decouples. Finally consistent with existing literature it was found that equity flows to the USA are autocorrelated. Originality/value – There is a broad literature on the dynamics of US investment in emerging and developed markets, but very little (if any) research that analyzes the dynamics of equity flows to the US, returns, and measures of valuation. Furthermore, the literature on the behavior of equity flows surrounding financial crises is scant, particularly for developed markets.
Studies in Economics and Finance – Emerald Publishing
Published: Aug 2, 2011
Keywords: United States of America; Cross border equity flows; P/E ratio; Return chasing; International investments