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Bubble Thy Neighbor: Portfolio Effects and Externalities from Capital Controls

48 Pages Posted: 12 May 2012  

Kristin J. Forbes

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER); Bank of England - Monetary Policy Committee

Marcel Fratzscher

DIW Berlin; Centre for Economic Policy Research (CEPR)

Thomas Kostka

European Central Bank (ECB)

Roland Straub

European Central Bank (ECB)

Multiple version iconThere are 4 versions of this paper

Date Written: April 27, 2012

Abstract

We use changes in Brazil’s tax on capital inflows from 2006 to 2011 to test for direct portfolio effects and externalities from capital controls on investor portfolios. The analysis is structured based on information from investor interviews. We find that an increase in Brazil’s tax on foreign investment in bonds causes investors to significantly decrease their portfolio allocations to Brazil in both bonds and equities. Investors simultaneously increase allocations to other countries that have substantial exposure to China and decrease allocations to countries viewed as more likely to use capital controls. Much of the effect of capital controls on portfolio flows appears to occur through signalling — i.e. changes in investor expectations about future policies — rather than the direct cost of the controls. This evidence of significant externalities from capital controls suggests that any assessment of controls should consider their effects on portfolio flows to other countries.

Keywords: capital controls, externalities, spillovers, portfolio effects, signalling, mutual funds, Brazil, emerging markets

JEL Classification: F3, F4, F5, G0, G1

Suggested Citation

Forbes, Kristin J. and Fratzscher, Marcel and Kostka, Thomas and Straub, Roland, Bubble Thy Neighbor: Portfolio Effects and Externalities from Capital Controls (April 27, 2012). MIT Sloan Research Paper No. 4962-12. Available at SSRN: https://ssrn.com/abstract=2056491 or http://dx.doi.org/10.2139/ssrn.2056491

Kristin J. Forbes (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

Room E62-416
Cambridge, MA 02142
United States
617-253-8996 (Phone)

HOME PAGE: http://web.mit.edu/kjforbes/www

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
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Bank of England - Monetary Policy Committee ( email )

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Marcel Fratzscher

DIW Berlin ( email )

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Berlin, 10117
Germany

Centre for Economic Policy Research (CEPR) ( email )

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London, EC1V 3PZ
United Kingdom

Thomas Kostka

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Roland Straub

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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