Abstract
Increased globalization in financial markets implies that the percentage of all shares under foreign ownership in domestic stock markets has been rising. The recent speculative attacks on the foreign exchange market in November 2000, followed by February 2001, led Turkey into a deep economic crisis. Real stock returns as an important indicator for a forthcoming or pending financial crisis, using net capital flows have already been established in Gazioglu (2003). In this article we explore the effects of capital inflows and outflows to real exchange rates and the real stock market returns, before, and after the financial crisis. We investigate the relationship between real exchange rate, real stock returns and capital flows. We decompose the foreign flows into real assets and liabilities, in order to investigate the possible long-term effect of inflows and outflows. Empirical investigation shows that the long-term relationship only appears between the real exchange rates and the real bank liabilities owned by the foreigners. The first half of the sub-period, which is the pre-crisis period, is dominated by capital inflows and outflows. These affect the real exchange rate whereas the second sub-period, which is the post-crisis period, is dominated by unstable the capital inflow and outflows causing the decline of real stock market returns and the depreciation of the currency. The post-financial crisis period demonstrates a long-lasting effect on lowering the stock market returns. This confirms the theoretical findings of this article.
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