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Abstract:
International mutual funds are key contributors to the globalization of financial markets and one of the main sources of capital flows to emerging economies. Despite their importance in emerging markets, little is known about their investment allocation and strategies. This paper provides an overview of mutual fund activity in emerging markets. First, we describe their relative size, asset allocation, and country allocation. Second, we focus on funds' behavior during emerging markets crises in the 1990s, analyzing data at both the fund-manager and fund-investor levels. Due to large redemptions and injections, funds' flows are not stable. Withdrawals from emerging markets during recent crises were large, which is consistent with existing evidence of financial contagion.

mutual funds, emerging markets, capital flows, equity investment, contagion, crises

Abstract:
How do mutual funds behave when they invest in emerging economies? For one thing, mutual funds' flows are not stable. Withdrawals from emerging markets during recent crises were large, which squares with existing evidence of financial contagion.

International mutual funds are one of the main channels for capital flows to emerging economies. Although mutual funds have become important contributors to financial market integration, little is known about their investment allocation and strategies. Kaminsky, Lyons, and Schmukler provide an overview of mutual fund activity in emerging markets.

First, they describe international mutual funds' relative size, asset allocation, and country allocation.

Second, they focus on fund behavior during crises, by analyzing data at the level of both investors and fund managers.

Among their findings: Equity investment in emerging markets has grown rapidly in the 1990s, much of it flowing through mutual funds. Collectively, these funds hold a sizable share of market capitalization in emerging economies. Asian and Latin American funds achieved the fastest growth, but are smaller than domestic U.S. funds and world funds.

When investing abroad, U.S. mutual funds invest more in equity than in bonds. World funds invest mainly in developed nations (Canada, Europe, Japan, and the United States). Ten percent of their investment is in Asia and Latin America. Mutual funds usually invest in a few countries within each region.

Mutual fund investment was very responsive to the crises of the 1990s. Withdrawals from emerging markets during recent crises were large, which squares with existing evidence of financial contagion.

Investments in Asian and Latin American mutual funds are volatile. Because redemptions and injections are large relative to total funds under management, funds' flows are not stable. The cash held by managers during injections and redemptions does not fluctuate significantly, so investors' actions are typically reflected in emerging market inflows and outflows.

This paper - a product of Macroeconomics and Growth, Development Research Group - is part of a larger effort in the group to understand the operation of financial markets and the effects of financial globalization. The study was funded by the Bank's Research Support Budget under the research project "Mutual Funds in Emerging Markets." The authors may be contacted at graciela@gwu.edu, lyons@haas.
berkeley.edu, or sschmukler@worldbank.org.

Abstract:
The abruptness and virulence of the 1997 Asian crises have led many to claim that these crises are of a new breed and were thus unforecastable. This paper examines 102 financial crises in 20 countries and concludes that the Asian crises are not of a new variety. Overall, the 1997 Asian crises, as well as previous crises elsewhere, occur when economies are in distress, making the degree of fragility of the economy a useful indicator of future crises. Based on this idea, the paper proposes different composite leading indicators of crises, evaluated in terms of accuracy both in-sample and out-of-sample.

Early Warnings, Currency Crises, Banking Crises

Abstract:
The abruptness and virulence of the 1997 Asian crises have led many to claim that these crises are of a new breed and thus they were unforecastable. This paper examines 102 financial crises in 20 countries and concludes that the Asian crises are not of a new variety. Overall, the 1997 Asian crises, as well as previous crises in other regions, occur when the economies are in distress, making the degree of fragility of the economy a useful indicator of future crises. Based on this idea, the paper proposes different composite leading indicators of crises, which are evaluated in terms of accuracy both in-sample and out-of-sample.

Abstract:
Changes in sovereign ratings affect country risk and stock returns. And these changes are transmitted across countries, with neighbor-country effects being more significant.

Financial market instability has received attention from both academic and policy circles. Rating agencies have been under particular scrutiny lately as promoters of financial excesses, upgrading countries in good times and downgrading them in bad. Using a panel of emerging economies, Kaminsky and Schmukler examine whether sovereign ratings affect financial markets.

The authors find that changes in sovereign ratings affect country risk and stock returns. They also find that these changes are transmitted across countries, with neighbor-country effects being more significant. Rating upgrades tend to follow market rallies; downgrades tend to follow market downturns. Countries with more vulnerable economies, as measured by low ratings, are more sensitive to changes in U.S. interest rates.

This paper - a product of Macroeconomics and Growth, Development Research Group - is part of a larger effort in the group to understand how financial markets work in developing countries. The authors may be contacted at graciela@gwu.edu or sschmukler@worldbank.org.

Abstract:
We examine the trading strategies of mutual funds in emerging markets. We develop a method for disentangling the behavior of fund managers from that of underlying investors. For both managers and investors, we strongly reject the null hypothesis of no momentum trading: mutual funds systematically sell losers and buy winners. Selling current losers and buying current winners is stronger during crises, and equally strong for managers and investors. Selling past losers and buying past winners is stronger for managers. Managers and investors also practice contagion trading - they sell (buy) assets from one country when asset prices fall (rise) in another.

Mutual funds, managers, investors, trading strategies, emerging markets, momentum, feedback trading, crisis, contagion

Abstract:
This paper addresses the trading strategies of mutual funds in emerging markets. The data set we develop permits analysis of these strategies at the level of individual portfolios. Methodoloically, a novel feature is our disentangling the behavior of managers from that of underlying investors. For both managers and investors, we strongly reject the null hypothesis of no momentum trading: funds' momentum trading is positive they systematically buy winners and sell losers. Contemporaneous momentum trading (buying current winners and selling current losers) is stronger during crises, and stronger for fund investors than for fund managers. Lagged momentum trading (buying past winners and selling past losers) is stronger during non-crisis, and stronger for fund managers. Investors also engage in contagion trading, i.e., they sell assets from one country when asset prices fall in another.

Abstract:
This study of an important class of investors-U.S. mutual funds-finds that mutual funds do engage in momentum trading (buying winners and selling losers). They also engage in contagion trading strategies (selling assets from one country when asset prices fall in another).

Kaminsky, Lyons, and Schmukler address the trading strategies of mutual funds in emerging markets. The data set they develop permits analyses of these strategies at the level of individual portfolios.

A methodologically novel feature of their analysis: they disentangle the behavior of fund managers from that of investors.

For both managers and investors, they strongly reject the null hypothesis of no momentum trading. Funds' momentum trading is positive: they systematically buy winners and sell losers.

Contemporaneous momentum trading (buying current winners and selling current losers) is stronger during crises, and stronger for fund investors than for fund managers.

Lagged momentum trading (buying past winners and selling past losers) is stronger during noncrises, and stronger for fund managers.

Investors also engage in contagion trading-selling assets from one country when asset prices fall in another.

These findings are based on data about mutual funds that represent only 10 percent of the market capitalization in the countries considered. Were it a larger share of the market, finding counterparties for their trades (the investors who buy when they sell and sell when they buy) would be difficult-and the premise that funds respond to contemporaneous returns rather than causing them would become tenuous.

This paper - a product of Macroeconomics and Growth, Development Research Group - is part of a larger effort in the group to understand capital flows to developing countries. The study was funded by the Bank`s Research Support Budget under the research project "Mutual Fund Investment in Developing Countries." The authors may be contacted at graciela@gwu.edu, lyons@haas.berkeley.edu, or sschmukler@worldbank.org.

Abstract:
Movements in stock prices in East Asia during the crisis in 1997-98 were triggered by both local and neighbor-country news. Having the highest impact was news about agreements with international organizations and credit rating agencies. But some changes seem to have been driven by herd instincts in the market itself, including overreactions to bad news.

In the chaotic financial environment of East Asia in 1997-98, daily changes in stock prices of as much as 10 percent became commonplace. Kaminsky and Schmukler analyze what type of news moved the market in those days of extreme market jitters.

They find that movements are triggered by both local and neighbor-country news. News about agreements with international organizations and credit rating agencies have the most weight.

Some of those large changes in stock prices, however, cannot be explained by any apparent substantial news but seem to be driven by herd instincts in the market itself.

On average, the one-day market rallies are sustained while the largest one-day losses are recovered - suggesting that investors overreact to bad news.

This paper - a product of Macroeconomics and Growth, Development Research Group - is part of a larger effort in the group to understand financial markets and financial crises. The study was funded by the Bank's Research Support Budget under research project "Capital Market Crises and Information" (RPO 682-26). Sergio Schmukler may be contacted at sschmukler@worldbank.org.

Abstract:
We examine the short- and long-run effects of financial liberalization on capital markets. To do so, we construct a new comprehensive chronology of financial liberalization in 28 mature and emerging market economies since 1973. We also construct an algorithm to identify booms and busts in stock market prices. Our results indicate that financial liberalization is followed by more pronounced boom-bust cycles in the short run. However, financial liberalization leads to more stable markets in the long run. Finally, we analyze the sequencing of liberalization and institutional reforms to understand the contrasting short- and long-run effects of liberalization.

financial liberalization, capital controls, financial integration, stock market prices, booms, busts, financial cycles

Abstract:
We examine the short- and long-run effects of financial liberalization on capital markets. To do so, we construct a new comprehensive chronology of financial liberalization in 28 mature and emerging economies since 1973. We also construct an algorithm to identify booms and busts in stock market prices. Our results indicate that financial liberalization is followed by more pronounced boom-bust cycles in the short run. However, financial liberalization leads to more stable markets in the long run. Finally, we analyze the sequencing of liberalization and institutional reforms to understand the contrasting short- and long-run effects of liberalization.

Abstract:
Kaminsky and Schmukler examine the short- and long-run effects of financial liberalization on capital markets. To do so, they construct a new comprehensive chronology of financial liberalization in 28 developed and emerging economies since 1973. The authors also construct an algorithm to identify booms and busts in stock market prices. The results indicate that financial liberalization is followed by more pronounced boom-bust cycles in the short run. But financial liberalization leads to more stable markets in the long run. Finally, the authors analyze the sequencing of liberalization and institutional reforms to understand the contrasting short- and long-run effects of liberalization.

This paper - a product of the Investment Climate Team, Development Research Group - is part of a larger effort in the group to understand financial globalization and integration. The study was jointly funded by the Latin American Regional Studies Program and the Research Support Budget under the research project "Understanding Capital Market Crises in Emerging Economies."

Abstract:
This paper examines the empirical evidence on currency crises and proposes a specific early warning system. This system involves monitoring the evolution of several indicators that tend to exhibit an unusual behavior in the periods preceding a crisis. When an indicator exceeds a certain threshold value, this is interpreted as a warning "signal" that a currency crisis may take place within the following 24 months. The variables that have the best track record within this approach include exports, deviations of the real exchange rate from trend, the ratio of broad money to gross international reserves, output, and equity prices.

Currency Crises, Leading Indicators, Survey

Abstract:
This paper undertakes an econometric investigation into the efficiency of commodity futures markets. Despite a considerable amount of empirical literature, there is no general consensus on whether or not the markets are efficient. The results of this study suggest that for certain commodities expected excess returns to futures speculation are non-zero, however, it is argued that these results do not necessarily imply that markets are inefficient, or that agents do not act rationally. The implications of the study for the cost of using the futures markets for hedging, and for the power of futures prices to forecast future spot prices, are also noted.

Abstract:
This paper studies whether capital controls affect the link between domestic and foreign stock market prices and interest rates. To examine the characteristics of international market integration and the effects of capital controls in the short- and long-run, we use band-pass filter techniques. We find that markets seem to be more linked at longer horizons. We also find little evidence that controls effectively segment domestic markets from foreign markets. When they do, the effects seem to be short lived. Moreover, the effects of controls on outflows do not seem to differ from those of controls on inflows.

Capital controls, restrictions on capital movement, financial integration, band-pass filter

Abstract:
Do controls on capital flows persistently isolate domestic markets from international markets? Or is the insulation they provide just ephemeral?

Kaminsky and Schmukler study whether capital controls affect the link between domestic and foreign stock market prices and interest rates. To examine the characteristics of international market integration and the effects of capital controls in the short and long run, they apply band-pass filter techniques to data from six emerging economies during the 1990s.

They find that markets seem to be linked more at longer horizons. Equity prices seem to be more connected internationally than interest rates.

They also find little evidence that controls effectively segment domestic markets from foreign markets. And when they do, the effects seem to be short-lived.

Moreover, the effects of controls on outflows do not seem to differ from those of controls on inflows. For example, controls on outflows in Venezuela during the 1994 crisis, and unremunerated reserve requirements in Chile and Colombia during a capital-inflow episode, seem to have shielded domestic markets at the most at very high frequencies.

The degree of financial sophistication does not seem to affect Kaminsky and Schmukler's conclusions on the insulation provided by capital controls. True, more developed financial markets, such as those in Brazil, are more closely linked to international markets than those in Colombia and Venezuela, which are far more illiquid. But capital controls do not seem to provide an extra cushion against international spillovers even in less developed markets.

This paper - a product of Macroeconomics and Growth, Development Research Group - is part of a larger effort in the group to understand the functioning of financial markets and the benefits of financial integration. The study was funded by the Bank's Research Support Budget under the research project "Financial Development and Contagion." The authors may be contacted at graciela@gwu.edu or sschmukler@worldbank.org.

Abstract:
This paper undertakes an econometric investigation into the presence of risk premium in commodity futures markets. The statistical tests are derived from a formal model of asset pricing and are applied to futures prices in a variety of commodity markets. The results suggest that for several commodities there is evidence of a time varying risk premium, particularly in futures contracts maturing six months ahead. The implications of the study for the efficiency of the futures markets and the costs of using these markets for hedging are also noted.

Abstract:
Based on a sample of 104 countries, we document four key stylized facts regarding the interaction between capital flows, fiscal policy, and monetary policy. First, net capital inflows are procyclical (i.e., external borrowing increases in good times and falls in bad times) in most OECD and developing countries. Second, fiscal policy is procyclical (i.e., government spending increases in good times and falls in bad times) for the majority of developing countries. Third, for emerging markets, monetary policy appears to be procyclical (i.e., policy rates are lowered in good times and raised in bad times). Fourth, in developing countries - and particularly for emerging markets - periods of capital inflows are associated with expansionary macroeconomic policies and periods of capital outflows with contractionary macroeconomic policies. In such countries, therefore, when it rains, it does indeed pour.

Abstract:
The plethora of currency crises around the world has fueled many theories on the causes of speculative attacks. The first-generation models focus on fiscal problems. The second-generation models emphasize countercyclical policies and self-fulfilling crises. In the 1990s, models pinpoint to financial excesses. With the crisis of Argentina in 2001, models of sovereign default have become popular again. While the theoretical literature has emphasized variety, the empirical literature has supported the 'one size fits all' models. This paper contributes to the empirical literature by assessing whether the crises of the last thirty years are of different varieties. Crises are found to be of six varieties. Four of those varieties are associated with domestic economic fragility. But crises can also be provoked by just adverse world market conditions, such as the reversal of international capital flows. The so-called sudden-stop phenomenon identifies the fifth variety of crises. Finally, a small number of crises occur in economies with immaculate fundamentals but this type of crises is not an emerging-market phenomenon.

Abstract:
Over the last 20 years, some financial events, such as devaluations or defaults, have triggered an immediate adverse chain reaction in other countries -- which we call fast and furious contagion. Yet, on other occasions, similar events have failed to trigger any immediate international reaction. We argue that fast and furious contagion episodes are characterized by "the unholy trinity": (i) they follow a large surge in capital flows; (ii) they come as a surprise; and (iii) they involve a leveraged common creditor. In contrast, when similar events have elicited little international reaction, they were widely anticipated and took place at a time when capital flows had already subsided.

Abstract:
The recent turmoil in currency markets in Asia, Europe, and Latin America has given a new impetus to the literature on currency crises. The literature originally linked currency crises to deteriorating economic fundamentals, but has more recently focused on self-fulfilling expectations and contagion. To assess the changing roles of domestic and external market fundamentals and contagion, this paper examines seven major currency crises in Argentina. It finds that while crises in the 1970s and 1980s were driven mainly by monetary and fiscal policies at home and abroad, contagion played an important role in the 1990s.

Argentina currency crises speculative attacks vector autoregressions

Abstract:
We study the pattern of volatility of gross issuance in international capital markets since 1980. We find several short-lived episodes of high volatility. Over the long run, however, volatility has declined, suggesting that international financial integration has not made financial markets more erratic. We use VAR analysis to examine the determinants of the time-varying pattern of volatility, focusing in particular on the role of financial centers. Our results suggest that a significant portion of the decline in volatility of issuance in international capital markets can be explained by the reduction in the volatility of U.S. interest rates.

Volatility, Issuance, International Financial Markets

Abstract:
In this paper, we examine which markets are most synchronized internationally and exhibit the greater extent of comovement. We focus on daily data for four asset markets: bonds, equities, foreign exchange, and domestic money market. Our sample covers thirty-five developed and emerging market countries during 1997-1999. The extent of comovement and responsiveness to external shocks is examined in different ways. To measure the response of these markets to adverse external shocks, we date the peaks in domestic interest rates and bond spreads and the largest daily declines in equity prices and assess the extent of clustering around the same period. We also analyze which markets show evidence of greatest comovement in general, irrespective of whether there are adverse shocks or not.

Abstract:
This paper studies how financial turbulence in emerging market countries can spread across borders. We construct indices of financial globalization' and evaluate the repercussions of turmoil in three emerging markets, which experienced financial crises in the late 1990s: Brazil, Russia, and Thailand. Our findings indicate that financial turbulence in these countries only spreads globally when they affect asset markets in one or more of the world's financial centers. Otherwise, spillovers are confined to countries in the same region. We also find that fragility in institutions in the financial centers is at the core of global spillovers while economic and monetary policy news contributes to regional spillovers.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
This paper examines Latin America's access to international capital markets from 1980 to 2005, with particular attention to the role of domestic and external factors. To capture access to international markets, we use primary gross issuance in international bond, equity, and syndicated-loan markets. Using panel estimation, we find that sound fundamentals matter. For example, Argentina, Brazil, and Chile's superb performance in capital markets during the early 1990s has been in large part driven by better fundamentals. However, the upsurge in international lending to Latin America starting in 2003 has been mainly driven by a dramatic increase in global liquidity.

Abstract:
Two propositions are common in the international finance literature: (1) the real exchange rate is a randoM walk, (2) the real exchange rate time series properties essentially depend on the nominal exchange rate regime. The first proposition has been used in support of the claim that PPP cannot even be considered a long run relationship since deviations from it are permanent in nature. The second proposit i on has been used as evidence of price stickiness. Contrary to the first proposition, this paper presents evidence that the random walk behavior of the real exchange rate is just a characteristic of the post-WWII period, while in the prewar period we observe the presence of transitory fluctuations. Also, although real exchange rate volatility appears to be different between fixed and flexible exchange rate regimes, these differences are not as systematic and large as the postwar data suggest.

Abstract:
No abstract is available for this paper.

Abstract:
We study the pattern of volatility of gross issuance in international capital markets since 1980. We find several short-lived episodes of high volatility. Over the long run, however, volatility has declined, suggesting that international financial integration has not made financial markets more erratic. We use VAR analysis to examine the determinants of the time-varying pattern of volatility, focusing in particular on the role of financial centers. Our results suggest that a significant portion of the decline in volatility of issuance in international capital markets can be explained by the reduction in the volatility of U.S. interest rates.

Abstract:
The crises in Mexico, Thailand, and Russia in the 1990s spread quite rapidly to countries as far apart as South Africa and Pakistan. In the aftermath of these crises, many emerging economies lost access to international capital markets. Using data on international primary issuance, this paper studies the determinants of contagion and sudden stops following those crises. The results indicate that contagion and sudden stops tend to occur in economies with financial fragility and current account problems. They also show that high integration in international capital markets exposes countries to sudden stops even in the absence of domestic vulnerabilities.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
This paper examines Argentina's currency crises from 1970 to 2001, with particular attention to the role of domestic and external factors. Using VAR estimations, we find that deteriorating domestic fundamentals matter. For example, at the core of the late 1980s crises was excessively loose monetary policy while a sharp output contration triggered the collapse of the currency board in January 2002. In contrast, adverse external shocks were at the heart of the 1995 crisis, with spillovers from the Mexican crisis and high world interest rates being key sources of financial distress.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
The views on financial liberalization are quite conflictive. Many argue that it triggers financial bubbles and crises. Others claim that financial liberalization allows markets to function properly and capital to move to its most profitable destination. The empirical evidence on these effects is not robust. This paper constructs a new comprehensive chronology of financial liberalization and shows that a key reason for the inconclusive evidence is that the effects of liberalization are time-varying. Financial liberalization is followed by large booms and busts only in the short run. In the long run institutions improve and financial markets tend to stabilize.

F30, F36, G12, G15

Abstract:
Changes in sovereign debt ratings and outlooks affect financial markets in emerging economies. They affect not only the instrument being rated (bonds) but also stocks. They directly impact the markets of the countries rated and generate cross-country contagion. The effects of rating and outlook changes are stronger during crises, in nontransparent economies, and in neighboring countries. Upgrades tend to take place during market rallies, whereas downgrades occur during downturns, providing support to the idea that credit rating agencies contribute to the instability in emerging financial markets.

credit ratings, credit outlook, emerging markets, country risk, bonds spread, stock returns, financial markets, spillover effects, contagion

Abstract:
Movements in stock prices in East Asia during the crisis in 1997-98 were triggered by both local and neighbor-country news. Having the highest impact was news about agreements with international organizations and credit rating agencies. But some changes seem to have been driven by herd instincts in the market itself, including overreactions to bad news. In the chaotic financial environment of East Asia in 1997-98, daily changes in stock prices of as much as 10 percent became commonplace. Kaminsky and Schmukler analyze what type of news moved the market in those days of extreme market jitters. They find that movements are triggered by both local and neighbor-country news. News about agreements with international organizations and credit rating agencies have the most weight. Some of those large changes in stock prices, however, cannot be explained by any apparent substantial news but seem to be driven by herd instincts in the market itself. On average, the one-day market rallies are sustained while the largest one-day losses are recovered - suggesting that investors overreact to bad news.