Working Paper

The cyclicality of (bilateral) capital inflows and outflows

Abstract: Recent research has shown that gross capital inflows and outflows are positively correlated and highly procyclical. This poses a puzzle since most theory predicts that capital inflows and outflows should be negatively correlated, and while capital inflows should be procyclical, capital outflows should be countercyclical. This previous work has examined the behavior of aggregate capital inflows and outflows (capital flows between a country and the rest of the world). This paper shows that bilateral capital inflows and outflows (flows between a pair of countries) are also positively correlated and strongly procyclical. This empirical finding poses a new puzzle. The data suggests that any model that can explain capital flows at the bilateral level needs to rely on market incompleteness and non-diversification. In addition, the data suggests that this positive correlation and procyclicality is largely the feature of crisis episodes. After controlling for crisis episodes, we find that bilateral capital flows move positively with GDP in the country receiving the capital and co-move negatively in the country sending the capital.

JEL Classification: F3; F4; G0; G1;

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Bibliographic Information

Provider: Federal Reserve Bank of Dallas

Part of Series: Globalization Institute Working Papers

Publication Date: 2015-08-01

Number: 247

Pages: 28 pages