Capital Flow Volatility: The Effects of Financial Development and Global Financial Conditions

Volatile international capital flows increase the risk of financial crises and reduce economic growth. The theoretical literature predicts that financial globalization will make capital flows more volatile. Importantly, the deepening of financial globalization has led to the emergence of the global financial cycle, which makes taming capital flows even more challenging. It is important to measure capital flow volatility and examine what factors affect it. In this paper, I estimate the time-varying capital flow volatility of 39 countries, including both advanced and emerging economies since 2000, and find that bank flows are the most volatile while foreign direct investment flows are the most stable. Panel regressions show that higher local financial development and more volatile and riskier global financial conditions increase capital flow volatility. I also find that there exists a threshold effect: financial volatility and risk in the global financial center are transmitted more strongly to countries that are more financially developed. The impulse responses of state-dependent local projections confirm the threshold effect and indicate that it is stronger for bank flows than for FDI and portfolio flows. These empirical findings provide insights into international capital flow management.