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Capital Flows to Emerging Markets: Liberalization, Overshooting, and Volatility

  • Philippe Bacchetta
  • Eric van Wincoop

The paper analyzes the impact of financial liberalizations and reforms in emerging markets on the dynamics of capital flows to these markets, using a simple model of international investors' behavior. We first show that the gradual nature of liberalizations, combined with the cost of absorbing large inflows in emerging economies, leads to rich dynamics of capital flows and often implies an initial period of overshooting as portfolios adjust. Asset prices will overshoot as well. Second, we show that if investors have incomplete information about new emerging markets, and learn over time, there can be high volatility of capital flows as well as contagion. Finally, we provide numerical estimates of long run capital inflows to emerging market economies and compare them to actual inflows. This gives a good indicator of upcoming crisis situations.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6530.

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Date of creation: Apr 1998
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Publication status: published as Capital Flows to Emerging Markets: Liberalization, Overshooting, and Volatility , Philippe Bacchetta, Eric van Wincoop. in Capital Flows and the Emerging Economies: Theory, Evidence, and Controversies , Edwards. 2000
Handle: RePEc:nbr:nberwo:6530
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