Uncertainty and International Capital Flows
Adrien Verdelhan () and
Francois Gourio ()
No 880, 2015 Meeting Papers from Society for Economic Dynamics
In a large panel of 26 emerging countries over the last 40 years, aggregate stock market return volatilities, our measure of uncertainty, forecast capital flows. When the stock market return volatility increases, capital inflows decrease and capital outflows increase. We propose a simple decomposition of each country's market return volatility into two components: countries differ by their exposure to systematic volatility, measured by their uncertainty betas, and by their country-specific volatility. Capital inflows respond to both systematic and country-specific shocks to volatility, and they respond more in high uncertainty beta countries. These results are all statistically significant. A simple portfolio choice model illustrates the impact of uncertainty on gross capital flows: in the model, foreigners are exposed to expropriation risk. When the probability of expropriation increases, foreigners sell the domestic assets to the domestic investors, leading to a counter-cyclical home bias.
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