What Drives Gross Flows in Equity and Investment Fund Shares in Luxembourg?

The paper analyses gross portfolio investment flows in equity and investment fund shares (EIFS) in Luxembourg - a small open economy with a financial center - over the period 2002Q1-2016Q3. The statistical analysis shows that gross EIFS flows exhibit similar patterns over time amongst resident investors and non-resident investors. However, the volatility of EIFS flows instigated by non-resident investors is larger than the volatility of EIFS flows initiated by resident investors. The graphical analysis provides evidence that gross EIFS flows switch between positive and negative growth cycles whose durations vary over time, depending on macroeconomic, financial and geopolitical shocks at the global level. In particular, gross EIFS flows correlate positively with stock returns and negatively with risk/uncertainty measures at the global level. Sudden and sharp increases (decreases) in gross EIFS flows concur with periods of bullish (bearish) equity markets and low (heightened) risk aversion. Econometric tests show that gross EIFS flows (including extreme movements) are driven by macroeconomic and financial variables at the global level. Eventually, a prediction exercise suggests that it is difficult to forecast extreme movements in gross EIFS flows based on global macroeconomic and financial variables.

Keywords: International finance, external statistics, balance of payments, equity and investment fund shares, gross flows, surges/flights, stops/retrenchments, graphical analysis, GMM estimation, discrete choice model, ROC analysis, prediction exercise