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Composition of International Capital Flows: A Survey

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  • Koralai Kirabaeva
  • Assaf Razin

Abstract

We survey several key mechanisms that explain the composition of international capital flows: foreign direct investment, foreign portfolio investment and debt flows (bank loans and bonds). In particular, we focus on the following market frictions: asymmetric information in capital markets and exposure to liquidity shocks. We show that the information asymmetry between foreign and domestic investors leads to inefficient investment allocation and borrowing in a country that finances its domestic investment through foreign debt or foreign equity. Exposure to liquidity shocks due to the mismatch of debt maturity may induce banking crises and cause sudden reversals of short-term capital flows. When there is asymmetric information between sellers and buyers in the capital market, then due to the adverse selection foreign direct investment is associated with higher liquidation costs than portfolio investment. The difference in exposure to liquidity shocks (in addition to asymmetric information) can explain the composition of equity flows between developed and emerging countries, and the patterns of foreign direct investments during financial crises.

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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 10-33.

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Length: 34 pages
Date of creation: 2010
Date of revision:
Handle: RePEc:bca:bocawp:10-33

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Citations

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Cited by:
  1. G. Andrew Karolyi & David T. Ng & Eswar S. Prasad, 2013. "The Coming Wave," Working Papers 082013, Hong Kong Institute for Monetary Research.
  2. Martin Schmitz, 2009. "Financial Reforms and Capital Flows to Emerging Europe," The Institute for International Integration Studies Discussion Paper Series iiisdp278, IIIS.
  3. Anton Jevcak & Ralph Setzer & Massimo Suardi, 2010. "Determinants of Capital Flows to the New EU Member States Before and During the Financial Crisis," European Economy - Economic Papers 425, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission.
  4. Davide Furceri & Stéphanie Guichard & Elena Rusticelli, 2012. "Medium-Term Determinants Of International Investment Positions: The Role Of Structural Policies," Journal of International Commerce, Economics and Policy (JICEP), World Scientific Publishing Co. Pte. Ltd., vol. 3(02), pages 1250012-1-1.

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