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Capital flows to Emerging Markets: Liberalization, Overshooting, and Volatility

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Author Info
Philippe Bacchetta () (Studienzentrum Gerzensee, Université de Lausanne, and CEPR)
Eric van Wincoop () (University of Virginia)

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Abstract

The paper analyzes the impact of financial liberalizations and reforms in emerging markets on the dynamics of capital flows to these markets, using a simple model of international investors' behavior. We first show that the gradual nature of liberalizations, combined with the cost of absorbing large inflows in emerging economies, leads to rich dynamics of capital flows and often implies an initial period of overshooting as portfolios adjust. Asset prices will overshoot as well. Second, we show that if investors have incomplete information about new emerging markets, and learn over time, there can be high volatility of capital flows as well as contagion. Finally, we provide numerical estimates of long run capital inflows to emerging market economies and compare them to actual inflows. This gives a good indicator of upcoming crisis situations.

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Paper provided by Swiss National Bank, Study Center Gerzensee in its series Working Papers with number 98.01.

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Length: 46 pages
Date of creation: Mar 1998
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Publication status: Forthcoming, Capital Inflows to Emerging Markets, Chicago University Press
Handle: RePEc:szg:worpap:9801

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  3. Bacchetta, Philippe, 1992. "Liberalization of Capital Movements and of the Domestic Financial System," Economica, London School of Economics and Political Science, vol. 59(236), pages 465-74, November. [Downloadable!] (restricted)
  4. Bacchetta, Philippe & Dellas, Harris, 1997. "Firm Restructuring and the Optimal Speed of Trade Reform," Oxford Economic Papers, Oxford University Press, vol. 49(2), pages 291-306, April. [Downloadable!] (restricted)
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  19. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June. [Downloadable!] (restricted)
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