Gross Capital Flows : Dynamics and Crises

This paper analyzes the joint behavior of international capital flows by foreigners and domestic agents over the business cycle and during financial crises. We show that gross capital flows by foreigners and domestic agents are very large and volatile relative to net capital flows. Namely, when foreigners invest in a country domestic agents tend to invest abroad, and vice versa. Gross capital flows are also pro-cyclical. During expansions, foreigners tend to bring in more capital and domestic agents tend to invest more abroad. During crises, especially during severe ones, there is retrenchment, i.e. a reduction in capital inflows by foreigners and an increase in capital inflows by domestic agents. This evidence sheds light on the nature of the shocks driving international capital flows and discriminates among existing theories. Our findings are consistent with shocks that affect foreigners and domestic agents asymmetrically - e.g. sovereign risk and asymmetric information - over productivity shocks