Working Paper: NBER ID: w27129
Authors: Chang Ma; Shangjin Wei
Abstract: Standard models of capital flows to emerging market economies focus on debt flows and a pecuniary externality. However, by offering better risk sharing, international equity flows can render such externality unimportant, yet many economies fail to attract equity investment in a large quantity. We propose a theory of endogenous composition of capital flows that highlights two asymmetries. In our model, poor institutional quality leads to an inefficiently low share of equity financing as well as an inefficiently high volume of total inflows. Somewhat surprisingly, a social planner would often impose taxes on both equity and debt inflows. Our story differs in important ways from an alternative narrative focusing on collateral constraint.
Keywords: capital flows; institutional quality; equity financing; debt financing; financial stability
JEL Codes: F3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Institutional Quality (L15) | Share of Equity Financing (G32) |
| Institutional Quality (L15) | Probability of Debt Crisis (F34) |
| Institutional Quality (L15) | Need for Capital Controls (F38) |