Abstract
• KF* is a new supply-side estimate of the natural level of capital flows. • KF* is a level to which portfolio flows converge in the medium term. • KF* greatly improves our ability to model notoriously volatile capital flows. • KF* performs well against out-of-sample and in-sample filtering techniques. • The gap between actual inflows and KF* helps predict both 6-quarters ahead sudden stop episodes and medium-term equity returns. • KF* helped predict capital flows during the two largest shocks of the past few decades: the global financial crisis and the Covid-19 shock. International portfolio flows converge in the medium run to a country-specific, supply-side estimate of their natural level. Our estimate of the natural level of capital flows, KF*, has impressive out-of-sample empirical features, greatly improves our ability to model notoriously volatile capital flows and performs well against out-of-sample and in-sample filtering techniques. Further, the gap between actual inflows and KF* helps predict sudden stop episodes, equity returns, and capital flows during the two largest shocks of the past few decades: the global financial crisis and the Covid-19 shock.
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