Overreaction in capital flows to emerging markets: Booms and sudden stops

Manuel Agosin and Franklin Huaita ()

Journal of International Money and Finance, 2012, vol. 31, issue 5, 1140-1155

Abstract: This paper applies the overreaction hypothesis of De Bont and Thaler [De Bont, W., Thaler, R., 1985. Does stock market overreact? Journal of Finance 40(3), 793–805], developed for stock price behavior, to capital flows to emerging markets. We find that a surge in capital flows, or what we call a capital boom, can predict future sharp contractions in capital flows, or sudden stops. We use a large list of possible economic fundamentals as control variables, and the results show that the best predictor of a sudden stop is a preceding capital boom. Moreover, the probability of a country undergoing a sudden stop increases considerably with the length of the boom: this probability more than doubles when the boom is three years old, and rises by three to four times when the boom lasts for four years. These results are interesting for two reasons. In the first place, they contradict previous studies that emphasize worsening fundamentals as the ultimate cause of a sudden stop. Second, they are of policy interest because of the enormous negative impacts that sudden stops have on the real economy.

Keywords: Capital flows; Emerging markets; Sudden stops; Overreaction (search for similar items in EconPapers)
JEL-codes: F30 F32 F39 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (66)

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Related works:
Working Paper: Overreaction in capital flows to emerging markets: Booms and sudden stops (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:31:y:2012:i:5:p:1140-1155

DOI: 10.1016/j.jimonfin.2011.12.015

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