The relationships among capital flow surges, reversals and sudden stops

Abstract

PurposeThis paper aims to investigate the relationship between capital flow surges, reversals and sudden stops.Design/methodology/approachEmphasizing the importance of looking at the behavior of domestic as well as foreign capital flows, the authors distinguish sudden stops from capital flow reversals by attributing the former to foreign capital flows only.FindingsIt is found that, despite the large differences in the number of surges identified by several different measures in the literature, a majority of surges do end in reversals of some type. The percentages tend to be slightly over half for surges in net capital flows, but on average, 70 per cent of gross surges end in sudden stops. Furthermore, contrary to popular belief, approximately half of sudden stops and net capital flow reversals are not preceded by surges. It is also found that surges that persist longer are more likely to turn into sudden stops and reversals.Research limitations/implicationsThe authors find substantial empirical differences in the characteristics of sudden stops (based on gross foreign flows) and reversals (based on net flows).Practical implicationsLarge inflows of financial capital are not always a strong indicator that a country’s economic policies will continue to provide stability in the future. They may signal an increase rather than reduction in the risk of future instability.Originality/valueThis study focuses on an issue that has been less explored to date, the relationship between capital flow surges, reversals and sudden stops. The authors distinguish, redefine and document differences among capital flow reversals and sudden stops. Duration of surges is related to the likelihood of having reversals and sudden stops.