Capital Control and Heterogeneous Impact on Capital Flows

This paper analyzes the heterogeneous direct and spillover effect of capital control on gross capital flows across three major institutional sectors namely public sector, banks and corporate. The paper examines the possible heterogeneity in the effect of capital control on the capital inflows to these institutional sectors using spatial econometric models. The empirical findings indicate that the direct effect of capital control moderates portfolio inflows to public sector whereas the portfolio inflows to banks and corporate sector does not respond to the capital control measures. The spillover effect of capital control increases capital inflows to all sectors in other countries. The paper explains the observed heterogeneity in the capital control effects by introducing signaling effect in a portfolio choice model. The paper argues that the heterogeneous direct effect is driven by private signals of capital control received by the investors about the state of economy whereas the spillover effect of capital control is mainly driven by the hedging and search for better yield.