International Equity and Debt Flows to Emerging Market Economies: Composition, Crises, and Controls

Abstract

Standard models of capital flows to emerging market economies focus on debt flows and a pecuniary externality. Equity flows, by offering better risk sharing, can render such externality unimportant, yet many economies fail to attract a significant amount of international equity investment. We propose a theory of endogenous composition of capital flows in which poor institutional quality leads to an inefficiently low equity share and an inefficiently high volume of total inflows. Interestingly, a planner would impose a tax on both debt and equity inflows. Our story differs in important ways from an alternative narrative focusing on collateral constraint.

Keywords: Capital Controls, Institutional Quality

JEL Classification: F38, F41, G18