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Capital Flows and Information Frictions

English title Capital Flows and Information Frictions
Applicant Benhima Kenza
Number 182195
Funding scheme Project funding (Div. I-III)
Research institution DEEP University of Lausanne
Institution of higher education University of Lausanne - LA
Main discipline Economics
Start/End 01.09.2019 - 31.08.2022
Approved amount 232'918.00
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Keywords (4)

International Capital Flows; SVAR; Information Frictions; Foreign currency borrowing

Lay Summary (French)

Lead
Les entrées et sorties brutes de capitaux sont volatiles et procycliques. Des flux de capitaux " exubérants " et " irrationnels " posent un défi politique ; mais en l'absence d'une bonne compréhension de ces phénomènes, des recommandations politiques peuvent difficilement être données. Notre projet vise à étudier, tant empiriquement que théoriquement, le rôle des frictions d'information afin d'expliquer la volatilité et la procyclicité des flux de capitaux.
Lay summary

Les asymétries d'information sont pertinentes pour expliquer les flux internationaux de capitaux, car les anticipations jouent un rôle clé dans toutes les décisions d'investissement. En particulier, les agents étrangers et nationaux ont accès à différentes sources d'information, ce qui est une source de désaccord, et donc génère des échanges d'actifs. Malgré le rôle central joué par les anticipations et l'information dans les flux de capitaux, le rôle de l'information n'est pas encore compris. Enfin, les frictions en matière d'information sont souvent évoquées comme un facteur potentiellement important pour expliquer les flux de capitaux, mais il existe peu de preuves empiriques de l'existence de ce canal. Nous nous concentrerons plus particulièrement sur les questions suivantes : i) Quel est le rôle joué par l'asymétrie de l'information pour expliquer les flux de capitaux ? (ii) Les frictions d'information peuvent-elles expliquer la procyclicité des flux bancaires ? iii) L'asymétrie de l'information peut-elle expliquer les emprunts en devises étrangères ?

Les études menées dans le cadre de ce projet contribueront non seulement à la littérature en étendant la question des frictions informationnelles à la dimension internationale, mais elles revêtent également une importance politique. La volatilité des flux de capitaux est une question cruciale pour la plupart des banques centrales des économies avancées et émergentes, y compris la Banque nationale suisse. Nous nous attendons donc à ce que les résultats de nos recherches trouvent un public au-delà des milieux universitaires.

Direct link to Lay Summary Last update: 11.06.2019

Responsible applicant and co-applicants

Employees

Name Institute

Project partner

Associated projects

Number Title Start Funding scheme
150068 News and Noise: Some Empirical and Theoretical Issues 01.09.2014 Project funding (Div. I-III)

Abstract

Gross capital inflows and outflows are large, volatile, and procyclical. Even in the absence of large net flows, changes in gross capital flows can be destabilizing, as the agents that hold foreign assets are not always the same as those who have foreign liabilities. Besides, “exuberant” and “irrational” capital flows pose a policy challenge; but in the absence of a good understanding of these phenomena, policy recommendations can hardly be given. Our proposed research aims at investigating, both empirically and theoretically, the role of information frictions in explaining the volatility and procyclicality of capital flows.Information asymmetries are particularly relevant in the context of international capital flows, as expectations, in general, play a key role in all investment decisions. Importantly, foreign and domestic agents have access to differing sources of information, which is a source of disagreement, and hence of trade. Despite the central role played by expectations and information in capital flows, the role of information has yet to be fully understood. Finally, information frictions are often evoked as a potentially important factor in shaping capital flows, but there is scarce evidence of this channel.The previous project “News an Noise: Some Empirical and Theoretical Issues” (2014-2017), conducted by the applicant Kenza Benhima, has focused on business cycle, policy and international issues related to information frictions. This project will further investigate their consequences on capital flows. Some of the sub-projects are follow-ups of the research conducted in this previous project.The first and second sub-projects will investigate, using panel SVAR methodologies, the role played by asymmetric information in explaining gross capital flows at business cycles frequencies. The first sub-project documents the responses of capital flows to expectation-related shocks, and shows that these responses are consistent with information asymmetries. Key to our analysis, we will build in the second sub-project an original dataset of time-varying disagreement between domestic and foreign agents for a panel of advanced and emerging countries. An identification method developed in the “News and noise” project will be employed to identify the effect of various types of expectation-related shocks on capital flows and on our disagreement measures. We will then be able to assess whether the reaction of disagreement to various shocks is consistent with the reaction of capital inflows and outflows.In the third sub-project, using a model of banking with costly information acquisition, we will examine how information frictions can account for the procyclicality of banking flows. We will then test the information channel using bilateral loan data. More specifically, we will determine whether country-pair and country-time specific determinants of the cost of information can explain the reaction of credit to global and local shocks. The fourth sub-project will focus on how asymmetric information can explain domestic vulnerabilities like foreign currency borrowing. Our theory shows that foreign currency borrowing is not a mere result of poor fundamentals, but can also arise from poor public information on those fundamentals. We test our theory using data on private bond issuance and disagreement among the main credit rating agencies to measure the quality of public information.This project will involve a doctoral student who will be in charge of building the datasets and will have the opportunity to contribute to one or several of the sub-projects and to be acquainted to state-of-the -art models and empirical methods. Student-assistants will also be involved in the data construction and other tasks. Finally, we plan to organize a workshop on capital flows. The purpose is to get together leading researchers in the field to present and discuss papers and to showcase the research conducted within the project.The studies conducted within this project will not only contribute to the literature by extending the issue of informational frictions to the international dimension, but they are also of first-order policy importance. The volatility of capital flows is a crucial question for most advanced and emerging economies’ central banks, including the Swiss National Bank, so we expect the results of our research to find an audience beyond the academic circles.
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