Uncertainty and International Capital Flows
60 Pages Posted: 5 Jul 2015 Last revised: 9 Oct 2015
Date Written: August 28, 2015
In a large panel of 26 emerging countries over the last 40 years, stock market return volatilities forecast capital flows. When a country’s stock market volatility increases, capital inflows decrease and capital outflows increase, with net flows slightly decreasing. We study one potential explanation for these results: expropriation risk. Empirically, we find that volatility forecasts political risk, and that political risk significantly affects capital flows. In a simple portfolio choice model, assuming that foreigners are more exposed to expropriation risk than local investors, an increase in the probability of expropriation leads foreigners to sell the domestic assets to the local investors, leading to a counter-cyclical home bias. This coincides with higher price volatility under plausible assumptions.
Keywords: international capital flows, political risk, expropriation, gross flows, volatility, uncertainty
JEL Classification: E32, E44, G12, F32
Suggested Citation: Suggested Citation