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Capital flows to Emerging Markets: Liberalization, Overshooting, and Volatility

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Abstract

The paper analyzes the impact of financial liberalizations and reforms in emerging markets on the dynamics of capital flows to these markets, using a simple model of international investors' behavior. We first show that the gradual nature of liberalizations, combined with the cost of absorbing large inflows in emerging economies, leads to rich dynamics of capital flows and often implies an initial period of overshooting as portfolios adjust. Asset prices will overshoot as well. Second, we show that if investors have incomplete information about new emerging markets, and learn over time, there can be high volatility of capital flows as well as contagion. Finally, we provide numerical estimates of long run capital inflows to emerging market economies and compare them to actual inflows. This gives a good indicator of upcoming crisis situations.

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Bibliographic Info

Paper provided by Swiss National Bank, Study Center Gerzensee in its series Working Papers with number 98.01.

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Length: 46 pages
Date of creation: Mar 1998
Date of revision:
Publication status: Forthcoming, Capital Inflows to Emerging Markets, Chicago University Press
Handle: RePEc:szg:worpap:9801

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