Ley Orgánica de Comunicación

Previous work done in the literature, includingCalvo et al.[1993], Mody et al.[2001], Chuhan et al.[1998] distinguishes between domestic-pull and global-push factors as the

determinants of international capital flows. Improving investment conditions in emerg- ing markets, including creditworthiness or returns,pull foreign investment in respective countries. Alternatively, worsening investment conditions in developed countries, in- cluding lower interest rates,push capital towards emerging markets.

Theoretically, with perfect capital mobility and no transaction, adjustment or infor- mation costs, one may expect the dynamics of capital flows to reflect the adjustment towards the optimal portfolio chosen by international investors. However, there is exten- sive evidence against investors forming their portfolios with respect to traditional port- folio choice models. One example is the home-bias puzzle (French & Poterba [1991]). Fernandez-Arias & Montiel[1996] argue that the observed flows are part of an adjust- ment mechanism, which ensures that the risk-adjusted project level domestic returns equal the alternative (foreign) returns. Authors argue that, in emerging markets, where creditworthiness is low, second moments (volatility and covariance of returns) may not be as important as traditional portfolio selection models emphasize. Another related strand of literature explores contagion; for instance Claessens et al.[2000]. At times, markets in di↵erent countries seem to exhibit correlations that are above the level that can be justified with real or financial linkages. Both contagion and herding can further increase the volatility and the inter-dependencies of capital flows to emerging markets.

In the light of the findings in the literature, capital flows seem to have many determi- nants and complex dynamics that are challenging to pinpoint and model. To do so, one must recognize the necessity of accounting for both the underlying domestic and foreign determinants, as well as other channels through which shocks may propagate. Mody et al.[2001], for that purpose, construct Vector Error Correction Models (VECMs) for emerging market countries in which the dynamics of flows are conditioned on both do- mestic and foreign fundamentals that are modelled in a separate Vector Autoregressive model (VAR) without any feedback from emerging market VECMs. More generally, there is a growing literature on modelling observed and unobserved international link- ages globally. For instance,D´ees et al.[2007b] argue for the need of a global modelling perspective to account for the rise in international interdependencies as a result of in- creasing real and financial linkages across countries. As a solution, they employ a Global Vector Autoregressive (GVAR) Model, in which standard VAR/VECM country models are augmented with cross sectional averages that are supposed to proxy for unobserved global factors. Then, resulting conditional models, VARX* and VECX*, are solved to yield a single Global VAR Model.

In the context of capital flows, there are many channels through which co-movements or interdependencies may result. Changes in the global push factors may result in a

change in the total supply of capital to be invested in emerging markets. Apart from push factors, as in D´ees et al. [2007b] or Chudik & Fratzscher [2011], the literature clearly identifies interdependencies among countries with strong financial or real link- ages. Hence, developments in one country would a↵ect the expected returns on foreign investment not only in that country, but also in other countries that have linkages with it. Assuming forward-looking rational investors, these developments need not be macro- financial, but may include other considerations that may influence future expected re- turns on investment, such as geo-political risks. Changes in investor sentiment, combined with herding, may result in surges or stops in capital flows to di↵erent countries simul- taneously.6 _{Such sudden stops and interdependencies may not necessarily result from} irrational behaviour. Claessens et al.[2000] argue that transmission of shocks to capi- tal flows, asset prices or exchange rates among recipient countries can be explained by liquidity and incentive problems faced by rational investors. Overall, these mechanisms would naturally result in spatial dependencies in foreign investment and co-movements in capital flows. In fact, recent papers in the literature suggest the presence of such de- pendencies across countries (see e.g. Forbes & Warnock[2012a] andGhosh et al.[2012]). Nevertheless, given the possible presence of numerous factors that cause the observed co-movements/interdependencies among flows to di↵erent countries, it is challenging to comprehensively list all of these factors, many of which may even be unobservable. For that reason, a common drawback of any empirical investigation of capital flows may be this inability to incorporate various relevant factors.

Apart from the well-documented domestic and global factors related to the dynamics, there is a growing interest in the multilateral dimension of issues related to international capital flows. In an on-going attempt by the International Monetary Fund to establish a coherent and comprehensive framework about how to deal with inflow surges, multilat- eral concerns are underscored to be important considerations in choosing an appropriate policy response.7 FollowingOstry et al.[2012], one of these concerns is the possible de- flection of capital flows from recipient countries that impose capital controls toward other recipient countries. In fact, Fratzscher et al. [2012a] document the presence of negative externalities resulted from the imposition of controls in Brazil recently.

6_{In this chapter, I define ”surges” and ”stops” as significant increases and decreases in gross capital}

flows, followingForbes & Warnock[2012a].

7_{See for instanceOstry et al. [2010], Ostry et al. [2011a], Ostry et al. [2012], IMF [2011b], IMF}