Exchange Rate Regimes, Capital Controls and the Pattern of Speculative Capital Flows

This paper proposes theoretical and empirical analysis of the effect of capital controls and alternative exchange rate regimes on the patterns of speculative capital. I argue that the exchange rate regime and its interaction with the monetary regime can explain the patterns of speculative capital around the world. I show that speculative capitals are more likely to flow into countries in which there is a contradiction between the monetary and the exchange regimes, e.g. more likely in countries with managed exchange rates. I model exchange-rate as a jump process in a stochastic dynamic portfolio optimization. Through this approach, the influence of the frequency and the size of "jumps" in the exchange rate on the allocation of speculative capital can be determined. It will also allow inflows to be endogenous. By linking the jumps to the frequency of exchange rate movements, this paper determines the effectiveness of different exchange rate regimes in fending off "hot money" for a given monetary regime. On the empirical side, I use a newly constructed data set to verify the theoretical predictions of the determinants and the patterns of speculative capital. Capital controls do not affect speculative capital.