The Effect of Capital Flows Composition on Output Volatility

47 Pages Posted: 20 Apr 2016

See all articles by Pablo Mariano Federico

Pablo Mariano Federico

BlackRock, Inc

Carlos A. Vegh

Johns Hopkins University - Paul H. Nitze School of Advanced International Studies (SAIS); University of Maryland - Department of Economics; University of California at Los Angeles; National Bureau of Economic Research (NBER)

Guillermo Vuletin

Brookings Institution

Date Written: March 1, 2013

Abstract

A large literature has argued that different types of capital flows have different consequences for macroeconomic stability. By distinguishing between foreign direct investment and portfolio and other investments, this paper studies the effects of the composition of capital inflows on output volatility. The paper develops a simple empirical model which, under certain conditions that hold in the data, yields three key testable implications. First, output volatility should depend positively on the volatilities of both foreign direct investment and portfolio and other inflows. Second, output volatility should be an increasing function of the correlation between both kinds of inflows. Third, output volatility should be a decreasing function of the share of foreign direct investment in total capital inflows, for low values of that share. The data provide strong support for all three implications, even after controlling for other factors that may influence output volatility, and after dealing with potential endogeneity problems. These findings call attention to the importance of taking into account the synchronization and composition of capital flows for output stabilization purposes, as opposed to just focusing on the volatility of each component of capital flows.

Keywords: Emerging Markets, Economic Conditions and Volatility, Investment and Investment Climate, Debt Markets, Economic Theory & Research

Suggested Citation

Federico, Pablo Mariano and Vegh, Carlos A. and Vuletin, Guillermo, The Effect of Capital Flows Composition on Output Volatility (March 1, 2013). World Bank Policy Research Working Paper No. 6386, Available at SSRN: https://ssrn.com/abstract=2236037

Pablo Mariano Federico (Contact Author)

BlackRock, Inc ( email )

55 East 52nd Street
New York City, NY 10055
United States

Carlos A. Vegh

Johns Hopkins University - Paul H. Nitze School of Advanced International Studies (SAIS) ( email )

1740 Massachusetts Avenue, NW
Washington, DC 20036-1984
United States

University of Maryland - Department of Economics ( email )

College Park, MD 20742
United States

University of California at Los Angeles ( email )

Box 951477
Los Angeles, CA 90095-1477
United States
310-825-7371 (Phone)
310-825-9528 (Fax)

HOME PAGE: http://vegh.sscnet.ucla.edu

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
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Guillermo Vuletin

Brookings Institution ( email )

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