Working Paper: CEPR ID: DP17012
Authors: Kenza Benhima; Rachel Cordonier
Abstract: We examine empirically the effect of two types of shocks related to expectations - "news" (increases in expected future productivity) and "sentiment" (surges in optimism unrelated to future productivity) - on gross capital flows. These two shocks together explain more than 80% of the variation in gross capital flows at all horizons, with the largest part being due to sentiment shocks. Both shocks drive a positive correlation between gross inflows and outflows but only sentiments shocks generate procyclical gross flows. We show that sentiment shocks are not accounted for by financial, monetary or uncertainty shocks, nor are they purely global. The empirical effect of news and sentiment shocks constitute a challenge to most theories of capital flows, but are consistent with the existence of asymmetric information betweendomestic and foreign investors about the country's fundamentals.
Keywords: capital flows; SVAR; expectations; asymmetric information
JEL Codes: D82; E32; F32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| news shocks (G14) | decrease in gross capital inflows (F21) |
| news shocks (G14) | decrease in gross capital outflows (F32) |
| news shocks (G14) | increase in home bias (F29) |
| sentiment shocks (E32) | increase in gross capital inflows (F21) |
| sentiment shocks (E32) | increase in gross capital outflows (F21) |
| sentiment shocks (E32) | decrease in home bias (F29) |
| news shocks (G14) | immediate negative response of capital flows (F32) |
| sentiment shocks (E32) | positive effects on capital flows (F32) |
| news shocks (G14) | capital flows (F32) |
| sentiment shocks (E32) | capital flows (F32) |