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A Theory of Capital Flow Retrenchment

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  • J. Scott Davis
  • Eric Van Wincoop

Abstract

The empirical literature shows that gross capital inflows and outflows both decline following a negative global shock. However, to generate a positive co-movement between gross inflows and outflows, the theoretical literature relies on asymmetric shocks across countries. We present a model where there is heterogeneity across investors within countries, but there are no asymmetries across countries. We show that a negative global shock (rise in global risk-aversion) generates an identical drop in gross inflows and outflows. The within-country heterogeneity relates to the willingness of investors to hold risky assets and foreign assets.

Suggested Citation

  • J. Scott Davis & Eric Van Wincoop, 2023. "A Theory of Capital Flow Retrenchment," Globalization Institute Working Papers 422, Federal Reserve Bank of Dallas.
    • Handle: RePEc:fip:feddgw:96609
    DOI: 10.24149/gwp422
    Note: This paper is related to a previous draft titled “A Theory of Gross and Net Capital Flows over the Global Financial Cycle.” This paper focuses on gross capital flows, while a separate paper considers net capital flows.
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    2. Guillermo Hausmann-Guil, 2025. "Solving DSGE models with incomplete markets by perturbation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 57, July.
    3. Davis, J. Scott & van Wincoop, Eric, 2025. "A theory of net capital flows over the global financial cycle," Journal of Monetary Economics, Elsevier, vol. 149(C).

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    JEL classification:

    • F30 - International Economics - - International Finance - - - General
    • F40 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - General

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