Unravelling the complex interactions between sentiment of uncertainty and foreign capital flows: Evidence from Brazil and South Korea

Abstract

Brazil and South Korea have both been known to implement capital controls during emerging market crises to address the complexity of foreign capital flows, which affects international investor behaviour. This research studies Brazil and South Korea bond and stock flows and sentiment of economic and political uncertainty (SEPU), a local news-based sentiment indicator, using a novel time-varying technique. Findings show multiple short-term occasions where increased SEPU strangely boosts equity flows, contrary to the assumption that uncertainty discourages equity investment. This paradoxical discovery is linked to a "behavioural arbitrage strategy" in which risk-seeking investors employ informational asymmetries to capitalize on increased uncertainty. Foreign investors prefer South Korean over Brazilian bonds due to the former country's stronger policy framework. The second significant finding is that equity inflows increase uncertainty (negative domestic sentiment in media) during acute crises. We conclude that inflation, recession, geopolitical risk, financial instability, and tight monetary policy amplify this feedback loop.