Why are Capital Flows so much more Volatile in Emerging than in Developed Countries?

Roberto Rigobon
Fernando Broner
Publication Type: 
Books and Book Chapters
Book Title: 
External Vulnerability and Preventive Policies
Book Editor: 
Ricardo Caballero, César Calderón, and Luis Felipe Céspedes
City of Publication: 
Santiago
Publisher: 
Central Bank of Chile
Pages: 
15-39
Publication Year: 
2006

The standard deviations of capital flows to emerging countries are 80 percent higher than those to developed countries. First, we show that very little of this difference can be explained by more volatile fundamentals or by higher sensitivity to fundamentals. Second, we show that most of the difference in volatility can be accounted for by three characteristics of capital flows: (i) capital flows to emerging countries are more subject to occasional large negative shocks (“crises”) than those to developed countries, (ii) shocks are subject to contagion, and (iii) – the most important one – shocks to capital flows to emerging countries are more persistent than those to developed countries. Finally, we study a number of country characteristics to determine which are most associated with capital flow volatility. Our results suggest that underdevelopment of domestic financial markets, weak institutions, and low income per capita, are all associated with capital flow volatility.

JEL Codes: 
F21, F32, F37, G15
Region: 
Global
Country: 
Global
Topic: 
International Finance
Topic: 
Risk
Topic: 
Financial Institutions