Do Demand Curves for Currencies Slope Down? Evidence from the MSCI Global Index Change

Do exchange rates react to exogenous capital movements? We explore this issue based on the redefinition of the MSCI international equity indices announced on 10 December 2000 and implemented in two steps on 30 November 2001 and 31 May 2002. The index changes implied major changes in the representation of different countries in the MSCI world index. Our event study shows a strong announcement effect in which countries with a decreasing equity representation vis-a-vis the US depreciated against the dollar. Around the two implementation dates, we find further systematic, but opposite, exchange rate effects, which can be interpreted as a result of excessive speculation on the first implementation date and insufficient speculation on the second date.