Uncertainty and International Capital Flows

60 Pages Posted: 5 Jul 2015 Last revised: 9 Oct 2015

See all articles by Francois Gourio

Francois Gourio

Federal Reserve Bank of Chicago

Michael Siemer

Board of Governors of the Federal Reserve System

Adrien Verdelhan

National Bureau of Economic Research (NBER); Massachusetts Institute of Technology (MIT) - Sloan School of Management

Date Written: August 28, 2015

Abstract

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

Gourio, Francois and Siemer, Michael and Verdelhan, Adrien and Verdelhan, Adrien, Uncertainty and International Capital Flows (August 28, 2015). Available at SSRN: https://ssrn.com/abstract=2626635 or http://dx.doi.org/10.2139/ssrn.2626635

Francois Gourio

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States

HOME PAGE: http://sites.google.com/site/fgourio

Michael Siemer (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

HOME PAGE: http://www.michael-siemer.com

Adrien Verdelhan

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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

100 Main Street
E62-416
Cambridge, MA 02142
United States

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