nep-ifn New Economics Papers
on International Finance
Issue of 2017‒09‒10
two papers chosen by
Vimal Balasubramaniam
University of Oxford

  1. Effects of capital controls on foreign exchange liquidity By Carlos Cantú
  2. How important is the Global Financial Cycle? Evidence from capital flows By Eugenio Cerutti; Stijn Claessens; Andrew K Rose

  1. By: Carlos Cantú
    Abstract: The literature on capital controls has focused on their use as tools to manage capital and improve macroeconomic and financial stability. However, there is a lack of analysis of their effect on foreign exchange (FX) market liquidity. In particular, technological and regulatory changes in FX markets over the past decade have had an influence on the effect of capital controls on alternative indicators of FX liquidity. In this paper, we introduce a theoretical model showing that, if capital controls are modelled as entry costs, then fewer investors will enter an economy. This will reduce the market's ability to accommodate large order flows without a significant change in the exchange rate (a market depth measure of liquidity). On the other hand, if capital controls are modelled as transaction costs, they can reduce the effective spread (a cost-based measure of liquidity). Using a panel of 20 emerging market economies and a novel measure of capital account restrictiveness, we provide empirical evidence showing that capital controls can reduce cost-based measures of FX market liquidity. The results imply that capital controls are effective in reducing the implicit cost component of FX market liquidity but can also have a negative structural effect on the FX market by making it more vulnerable to order flow imbalances.
    Keywords: capital flow management policies, foreign exchange market, market liquidity, market depth
    JEL: F31 G11 G15
    Date: 2017–08
  2. By: Eugenio Cerutti; Stijn Claessens; Andrew K Rose
    Abstract: This study quantifies the importance of a Global Financial Cycle (GFCy) for capital flows. We use capital flow data disaggregated by direction and type between Q1 1990 and Q4 2015 for 85 countries, and conventional techniques, models and metrics. Since the GFCy is an unobservable concept, we use two methods to represent it: directly observable variables in centre economies often linked to it, such as the VIX; and indirect manifestations, proxied by common dynamic factors extracted from actual capital flows. Our evidence seems mostly inconsistent with a significant and conspicuous GFCy; the two methods combined rarely explain more than a quarter of the variation in capital flows. Succinctly, most variation in capital flows does not seem to be the result of common shocks nor stem from observables in a central country like the United States.
    Keywords: empirical, data, centre, country, panel, fit, VIX, equity, bonds, FDI, credit
    JEL: F32 F36 G15
    Date: 2017–08

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