Political risk and capital flight

Capital flight often amounts to a substantial proportion of GDP when developing countries face crises. This paper presents a portfolio choice model that relates capital flight to rate of return differentials, risk aversion, and three types of risk: financial risk, political risk, and policy risk. Estimating the equilibrium capital flight equation for a panel of 47 developing countries over 16 years, we show that all three types of risk have a statistically significant impact on capital flight. Quantitatively, political risk is the most important factor causing capital flight. We also identify several political factors that reduce capital flight by signaling market-oriented reforms are imminent.