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Rare Institutional Disruptions and Uphill Capital Flows


  • Lance Kent

    () (Department of Economics, College of William and Mary)


The puzzle of "uphill capital flows," where capital flows out of countries with relatively lower capital stocks and faster-growing TFP, has reattained prominence in the two decades preceding the recent financial crisis in the form of a large and persistent United States trade deficit with the rest of the world. Asymmetric investment risk has been shown in other studies to be a significant driver of capital flows between countries; how large does the risk have to be to drive capital uphill? This paper builds a model with two large open economies to assess the strength of asymmetric risk as an "uphill" force against the neoclassical "downhill" forces. I assess the model calibrating the foreign country as China, since its "downhill" forces are quite strong. The model shows that if risk arises from only the estimated Gaussian noise of TFP, relatively high coefficients of risk aversion are needed to rationalize the large and steadily growing holdings by foreigners of US assets over the decades preceding the crisis. However, TFP in middleincome countries is subject to other shocks besides Gaussian noise. Recent studies have documented the probability and magnitude of drops in output attributable to rare disruptions to political institutions. This paper shows that this additional risk, even at moderate levels of risk aversion, is enough to drive Foreign investors to engage in decades-long flows of precautionary savings into the United States and quantitatively dominate the effect of Foreign TFP catchup.

Suggested Citation

  • Lance Kent, 2013. "Rare Institutional Disruptions and Uphill Capital Flows," Working Papers 146, Department of Economics, College of William and Mary.
  • Handle: RePEc:cwm:wpaper:146

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    References listed on IDEAS

    1. Elias Papaioannou & Gregorios Siourounis, 2008. "Democratisation and Growth," Economic Journal, Royal Economic Society, vol. 118(532), pages 1520-1551, October.
    2. Valerie A. Ramey, 2011. "Identifying Government Spending Shocks: It's all in the Timing," The Quarterly Journal of Economics, Oxford University Press, vol. 126(1), pages 1-50.
    3. repec:cup:apsrev:v:97:y:2003:i:01:p:75-90_00 is not listed on IDEAS
    4. Nicholas Bloom, 2009. "The Impact of Uncertainty Shocks," Econometrica, Econometric Society, vol. 77(3), pages 623-685, May.
    5. Daron Acemoglu & James A. Robinson, 2000. "Why Did the West Extend the Franchise? Democracy, Inequality, and Growth in Historical Perspective," The Quarterly Journal of Economics, Oxford University Press, vol. 115(4), pages 1167-1199.
    6. Acemoglu, Daron & Robinson, James A., 2000. "Democratization or repression?," European Economic Review, Elsevier, vol. 44(4-6), pages 683-693, May.
    7. Xavier Gabaix, 2012. "Variable Rare Disasters: An Exactly Solved Framework for Ten Puzzles in Macro-Finance," The Quarterly Journal of Economics, Oxford University Press, vol. 127(2), pages 645-700.
    8. Robert J. Barro, 2006. "Rare Disasters and Asset Markets in the Twentieth Century," The Quarterly Journal of Economics, Oxford University Press, vol. 121(3), pages 823-866.
    9. Dominik Noe & Admasu Shiferaw, 2013. "Low-intensity Conflict and Firm Level Investment in Ethiopia," Working Papers 141, Department of Economics, College of William and Mary, revised 05 Dec 2013.
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    Cited by:

    1. Coeurdacier, Nicolas & Rey, Hélène & Winant, Pablo, 2015. "Financial Integration and Growth in a Risky World," CEPR Discussion Papers 11009, C.E.P.R. Discussion Papers.

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    Capital Flows; Portfolio Choice; Rare Disasters; Precautionary Saving.;

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