Economic Policy Uncertainty and Global Portfolio Allocations

We examine how global institutional funds respond to news-based economic policy uncertainty (EPU) in the investment destination and home country. We document a number of novel findings. First, on an average there exists a negative flow-EPU relationship for global funds. Second, we document a novel "home effect." An average fund does not withdraw capital from the home country when EPU spikes in the home country, but it is a special feature of G7 economies. Funds domiciled in ex-G7 and developing countries reduce capital allocation when home EPU increases. Third, there is a pecking order of negative flow-EPU relationship when focusing on EPU of destination countries. The magnitude of the relationship follows the following order: emerging > ex-G7 advanced > G7. We also show a novel channel of transmission of uncertainty-related shocks. If EPU spikes in some countries of a fund's portfolio and not in other portfolio (non-impacted) countries, funds withdraw capital even from the non-impacted countries. Overall, our study shows that global funds may propagate financial shocks in response to economic uncertainty.