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Capital flow to China and the issue of hot money: an empirical investigation

  • Lai, Jennifer /J.T.
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    This paper tries to model the time series characteristics of capital flows to China over the period 1999-2008, namely bond flows (BF), equity flows (EF), bank credit (BC), and foreign direct investment (FDI). By utilizing the state space model and using Kalman filtering algorithm with maximum likelihood estimation, we try to gauge the relative importance of permanent and temporary components of each series. And by incorporating intervention and explanatory variables, we also try to detect if capital control measure imposed by the Chinese government and market sentiment of RMB foreign exchange rate appreciation expectation have any effect upon those flows. The empirical result shows that: all four flows are dominated by transitory component, among which BC flows have a relatively large permanent component and are the only series that are sensitive to market sentiment measure. In addition, capital control measures successfully skewed flows to come in through FDI and bond flow channels instead of equity flows. And our extended model with intervention and explanatory variables for those flows have better prediction performance compared to Sarno and Taylor (1999a) and the benchmark models.

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    File URL: http://mpra.ub.uni-muenchen.de/32539/1/MPRA_paper_32539.pdf
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    Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 32539.

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    Date of creation: Sep 2008
    Date of revision: Sep 2009
    Handle: RePEc:pra:mprapa:32539
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    1. Sarno, Lucio & Taylor, Mark P., 1999. "Moral hazard, asset price bubbles, capital flows, and the East Asian crisis:: the first tests," Journal of International Money and Finance, Elsevier, vol. 18(4), pages 637-657, August.
    2. Guonan Ma & RobertN McCauley, 2008. "Efficacy Of China'S Capital Controls: Evidence From Price And Flow Data," Pacific Economic Review, Wiley Blackwell, vol. 13(1), pages 104-123, 02.
    3. Francis E. Warnock & Hali J. Edison, 2001. "A Simple Measure of the Intensity of Capital Controls," IMF Working Papers 01/180, International Monetary Fund.
    4. Chuhan, Punam & Claessens, Stijn & Mamingi, Nlandu, 1998. "Equity and bond flows to Latin America and Asia: the role of global and country factors," Journal of Development Economics, Elsevier, vol. 55(2), pages 439-463, April.
    5. Durbin, James & Koopman, Siem Jan, 2001. "Time Series Analysis by State Space Methods," OUP Catalogue, Oxford University Press, number 9780198523543, March.
    6. Mohsen Bahmani-Oskooee & Ford Brown, 2004. "Kalman filter approach to estimate the demand for international reserves," Applied Economics, Taylor & Francis Journals, vol. 36(15), pages 1655-1668.
    7. Ashoka Mody & Mark Taylor & Jung Yeon Kim, 2001. "Forecasting capital flows to emerging markets: a Kalman filtering approach," Applied Financial Economics, Taylor & Francis Journals, vol. 11(6), pages 581-589.
    8. Gunter, Frank R., 2004. "Capital flight from China: 1984-2001," China Economic Review, Elsevier, vol. 15(1), pages 63-85, January.
    9. Gunter, Frank R., 1996. "Capital flight from the People's Republic of China: 1984-1994," China Economic Review, Elsevier, vol. 7(1), pages 77-96.
    10. 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.
    11. Ljungwall, Christer & Wang, Zijian, 2008. "Why is capital flowing out of China?," China Economic Review, Elsevier, vol. 19(3), pages 359-372, September.
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