The Volatility Of International Capital Flows And Risk Management

During the 1990's, due to the increased integration of world economy and improved economic performance and structural reforms in developing countries, they experienced a rapid expansion of capital inflows. In these countries large capital inflows boosted growth by increasing investment and consumption, but they are not an unmitigated blessing. They can lead to serials of macroeconomic shocks, such as inflationary pressures, real exchange rate appreciation, and overheating in economy. But a more severe shock comes from the volatility of international capital flows. As to the developing counties with fragile financial systems and high ratio of short-term foreign debts, sudden reversal of international capital flows can lead to great loss. Relying on stringent capital controls, China survived in Asia Crisis. However, with accelerated steps to WTO and more external financial liberalization, volatility of international capital flows will have more influence on internal financial markets. So study on volatility of international capital flows becomes an urgent project in the field of international finance.This dissertation will examine the characteristics, causes and risk management of volatility of international capital flows .It is divided into four sections. Section 1 describes main characteristics of the volatility of international capital flows. Section 2 analyzes the causes of volatility of international capital flows. Section 3 describes approaches and policy responses of risk management. The final section examines problems of capital flows of China and presents policy options.The introduction reviews the theoretical and practical backgrounds of the dissertation, together with some terminologies as well. Section 1 describes the main characteristics of the volatility of international capital flows. In the 1990's net capital flows to developing counties increased markedly, and the composition of capital flows shifted in favor of private flows and Foreign Direct Investments (FDI). But the flow is volatile. Using three kinds of statistic approaches to measure the volatility of international capital flows, it shows that in many countries volatility in the 1990's is higher than 1980's and short-term flows is the most volatile component in total flows. The volatility of international capital flows lead to more instability in internal financial markets and fragility in financial systems, and is linked with volatile growth. Section 2 analyzes the causes of volatility of international capital flows. At first it shows a survey of the determinants of international short-term capital movements, including classic flow theory, modern flow theory and international portfolio theory. All of these theories consider that the asset return differentials, especially interest rate differential are the main determinants of international short-term capital movements. This conclusion can give a sound explanation to the inflow in early 1990's,but cannot explain the sudden large reveals in late 1990's.The following analysis is based on a model of a small open economy, which adopts fixed exchange rate regime. Capital inflow can lead to expansion of aggregate demand and change of relative price between tradable goods and non-tradable goods. So relative return between different industry sectors is changed which will result in cyclical change in economy and international capital flows.Above analysis assume that the market is complete, but in fact financial markets are imperfect, and asymmetric information can cause noise-trading, moral hazard and herd behavior. All this will make capital flows more volatile. Additionally the volatility can spread to other counties through contagion effect. High leverage of financial derivatives may amplify the volatility. Lack of transparence in over-the-counter market makes the systematic market risk harder to discern, and the use derivatives can circumvent prudential supervision and add risk exposure. There are some flaws in current international monetary system. This system puts exces...