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Do Some Forms of Financial Flows Help Protect Against "Sudden Stops"?

  • Paolo Mauro

There is a debate on whether some forms of financial flows offer better protection against crises than others. Using a large panel data set that includes advanced, emerging, and developing economies during 1970--2003, this article analyzes the behavior of several types of flows: foreign direct investment (FDI), portfolio equity investment, portfolio debt investment, other flows to the official sector, other flows to banks, and other flows to the nonbank private sector. Differences across types of flows are limited with respect to volatility, persistence, cross-country comovement, and correlation with growth at home or in the world economy. However, consistent with conventional wisdom, FDI is the least volatile form of financial flow, when the average size of net or gross flows is taken into account. The differences are striking during "sudden stops" in financial flows (defined as drops in total net financial inflows of more than percentage points of GDP compared with the previous year). In such episodes, FDI is remarkably stable, and portfolio equity seems to play a limited role. Portfolio debt experiences a reversal, though it recovers relatively quickly, and other flows (including bank loans and trade credit) experience severe drops and often remain depressed for a few years. Copyright The Author 2007. Published by Oxford University Press on behalf of the International Bank for Reconstruction and Development / the world bank . All rights reserved. For permissions, please e-mail: journals.permissions@oxfordjournals.org, Oxford University Press.

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Article provided by World Bank Group in its journal The World Bank Economic Review.

Volume (Year): 21 (2007)
Issue (Month): 3 (September)
Pages: 389-411

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Handle: RePEc:oup:wbecrv:v:21:y:2007:i:3:p:389-411
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  1. Guillermo A. Calvo & Alejandro Izquierdo & Luis-Fernando Mejia, 2004. "On the Empirics of Sudden Stops: The Relevance of Balance-Sheet Effects," NBER Working Papers 10520, National Bureau of Economic Research, Inc.
  2. Kenneth Rogoff, 1999. "International Institutions for Reducing Global Financial Instability," NBER Working Papers 7265, National Bureau of Economic Research, Inc.
  3. Reinhart, Carmen & Calvo, Guillermo & Leiderman, Leonardo, 1993. "“Capital Inflows and Real Exchange Rate Appreciation in Latin America: The Role of External Factors," MPRA Paper 7125, University Library of Munich, Germany.
  4. Faria, Andr & Mauro, Paolo, 2009. "Institutions and the external capital structure of countries," Journal of International Money and Finance, Elsevier, vol. 28(3), pages 367-391, April.
  5. Robert E. Lipsey, 2001. "Foreign Direct Investors in Three Financial Crises," NBER Working Papers 8084, National Bureau of Economic Research, Inc.
  6. Carmen M. Reinhart & Kenneth S. Rogoff, 2004. "The Modern History of Exchange Rate Arrangements: A Reinterpretation," The Quarterly Journal of Economics, MIT Press, vol. 119(1), pages 1-48, February.
  7. Sarno, Lucio & Taylor, Mark P., 1999. "Hot money, accounting labels and the permanence of capital flows to developing countries: an empirical investigation," Journal of Development Economics, Elsevier, vol. 59(2), pages 337-364, August.
  8. Wei, Shang-Jin, 2001. "Domestic Crony Capitalism and International Fickle Capital: Is There a Connection?," International Finance, Wiley Blackwell, vol. 4(1), pages 15-45, Spring.
  9. Alexander D. Rothenberg & Francis E. Warnock, 2006. "Sudden Flight and True Sudden Stops," NBER Working Papers 12726, National Bureau of Economic Research, Inc.
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