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Political Risk and Capital Flight

  • Quan Le

    (Claremont Graduate University)

  • Paul J. Zak

    (Claremont Graduate University)

Capital flight often amounts to a substantial proportion of GDP when developing countries face crises. This paper presents a portfolio choice model that relates capital flight to rate of return differentials, risk aversion, and three types of risk: financial risk, political risk, and policy risk. Estimating the equilibrium capital flight equation for a panel of 47 developing countries over 16 years, we show that all three types of risk have a statistically significant impact on capital flight. Quantitatively, political risk is the most important factor causing capital flight. We also identify several political factors that reduce capital flight by signaling market-oriented reforms are imminent.

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Paper provided by Claremont Colleges in its series Claremont Colleges Working Papers with number 2001-10.

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Date of creation: May 2001
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Handle: RePEc:clm:clmeco:2001-10
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  1. Clague, Christopher & Keefer, Philip & Knack, Stephen & Olson, Mancur, 1999. "Contract Intensive Money," MPRA Paper 25717, University Library of Munich, Germany.
  2. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
  3. Eaton, Jonathan & Turnovsky, Stephen J, 1983. "Exchange Risk, Political Risk, and Macroeconomic Equilibrium," American Economic Review, American Economic Association, vol. 73(1), pages 183-89, March.
  4. Michael P. Dooley & Peter Isard, 1978. "Capital controls, political risk and interest disparities," International Finance Discussion Papers 125, Board of Governors of the Federal Reserve System (U.S.).
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