In Search of Early Warning Signals of Country Risk: Focusing on Capital Flight

Abstract

This chapter explores the insights which can be gained from the analysis of a country’s capital flight. The available market-based indicators of Country Risk—including bond yields, spreads, stock market indices, and Credit Default Swaps—do not consistently serve as reliable early warning signals. Country risk managers, therefore, need to put themselves in the shoes of domestic residents of foreign countries. We argue (and demonstrate through econometric modeling) that it is particularly valuable to examine how foreign residents manage their savings and liquid assets. We further investigate the relationship between governance and private capital outflows, giving specific focus to hydrocarbon exporting economies where wealth concentration constitutes an additional driving force behind corruption and capital flight. We argue that the greater the corruption and the less credible the government’s policy, the larger the capital leakages.