The Dynamics of International Capital Flows: Results from a Dynamic Hierarchical Factor Model
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Abstract
The present paper examines the degree of comovement of gross capital
inflows, which is a highly sensitive issue for policy makers. We estimate
a dynamic hierarchical factor model that is able to decompose inflows
in a sample of 47 economies into (i) a global factor common to all types
of flows and all recipient countries, (ii) a factor specific to a given type
of capital inflows, (iii) a regional factor and (iv) a country-specific component.
We find that the latter explains by far the largest fraction of
fluctuations in capital inflows followed by regional factors, which are
particularly important for emerging markets’ FDI and portfolio inflows
as well as bank lending to emerging Europe. The global factor, however,
explains only a small share of overall variation. The exposure to global
drivers of capital flows, i.e. the global factor and the factor specific to
each type of capital inflows, is particularly pronounced for countries
with a more developed financial system. A fixed exchange rate regime
does not shield countries from the ebb and flow of global capital flow
cycles.
Keywords
dynamic hierarchical factor model, Capital flows, financial crises, emerging economies