Shorting the Dollar When Global Stock Markets Roar: The Equity Hedging Channel of Exchange Rate Determination

Abstract This paper investigates the influence of global equity market value shocks on institutional investors’ (IIs’) hedging behavior and the resultant effects on exchange rates. Employing unique granular daily data on Israeli IIs’ foreign exchange (FX) forward flows and prices and a granular instrumental variable estimation approach, we find that foreign equity market value shocks generate significant selling of U.S. dollar forwards by IIs, as a hedge against heightened FX exposure, along with significant exchange rate appreciation. A value-shock-induced one-standard-deviation increase in IIs’ supply of forward flows appreciates IIs’ forward rate by 0.53%. (JEL E44, F3, F31, G15, G23)