Capital flows and asset prices: Empirical evidence from emerging and developing economies

This paper aims at providing empirical evidence on the effect of capital flows on asset prices including its channel under different currency regimes. To this end, we focus, on 10 emerging and developing economies and rely on a generalized impulse response analysis under a vector auto-regression model. The main findings are as follows. Portfolio capital inflows have a significantly positive effect on stock prices in all sample economies except two transition economies, which implies that the direct channel from capital inflows into stock markets is at least working in sample economies regardless of their currency regimes. The indirect channel – the channel in which capital inflows raise share prices through an increase in domestic monetary base – works differently under different currency regimes: it works in the economies with peg regime through their intervention to foreign exchange markets, whereas the indirect channel seems to be shut down in those with floating regime probably by sterilizing the intervention.