Interaction between Exchange Rates and Foreign Investor Behaviors in the Chinese Bond Market

Purpose – This paper investigates the interaction between the exchange rate and foreign bond investor behaviors in China using monthly time series data, which was available from the public database of the People’s Bank of China (PBC). Design/Methodology/Approach – The empirical data period is a sample of monthly time series data from 2014 to 2019. To analyze the interaction between the exchange rate and foreign bond investor behavior, we employed impulse response function (IRF) and variance decomposition (VDC) analyses based on the vector auto regression (VAR) model. Findings – According to estimation results, exchange rates have a significant negative effect on foreign bond investors, suggesting that foreign capital flows into the Chinese bond market decrease when the RMB depreciates against the US dollar. This implies that foreign investors fancy the RMB’s future earnings because these future earnings can be converted into more US dollars. Inversely, foreign capital flows into the Chinese bond market did not have a significant impact on the exchange rate of the RMB, which is due to the relatively small scale of investments in Chinese sovereign bonds by overseas financial institutions compared to other investments. Furthermore, according to the empirical analysis results, Chinese bond yields have a significant positive impact on foreign bond investor behaviors. At the same time, the yields of the Chinese and US bond markets move in the same direction. These findings indicate that local currency bond yields are affected by global monetary conditions. Research Implications – To further confirm the influence of foreign investment behavior on the RMB exchange rate in this study, we added interaction variables between foreign bond investment and opening policy to analyze the impact response of the exchange rate. The results showed an obvious negative impact, thereby illustrating that the impulse of foreign bond investment on the RMB per US dollar exchange rate is affected by the open policies of the Chinese bond market.