Sudden stops of international fund flows: Occurrence and magnitude

• Author: Jakob de Haan,Suxiao Li,Bert Scholtens
• Date: 01 February 2019
• Published date: 01 February 2019
• DOI: http://doi.org/10.1111/roie.12385

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© 2018 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/roie Rev Int Econ. 2019;27:468–497.

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INTRODUCTION

Edwards (2004, p. 59) defines a sudden stop as “an abrupt and major reduction in capital inflows to

a country that has been receiving large volumes of foreign capital.” Sudden stops are associated with

several financial and economic disruptions, such as a depreciation of the real exchange rate (Calvo &

Reinhart, 2000), higher costs of external finance (Calvo & Talvi, 2005), an increase in nonperforming

bank loans (Calvo, Izquierdo, & Mejia, 2004), and banking and currency crises (De Mello, Padoan, &

Rousová, 2012). If a country is cut off from international capital markets, investments and economic

growth will drop (Calvo & Talvi, 2005). Edwards (2007) shows that sudden stops lead to an average

Received: 8 October 2016

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Revised: 12 April 2018

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Accepted: 1 November 2018

DOI: 10.1111/roie.12385

ORIGINAL ARTICLE

Sudden stops of international fund flows:

Occurrence and magnitude

Suxiao Li1,2,3

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Jakob de Haan2,4,5

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Bert Scholtens2,6

1Postdoctoral Workstation, Industrial and

Commercial Bank of China, Beijing, China

2Faculty of Economics and Business,

University of Groningen, Groningen,

The Netherlands

3School of Economics and

Management,University of Chinese

Academy of Sciences, Beijing, China

4De Nederlandsche Bank, Amsterdam, The

Netherlands

5CESifo, Munich, Germany

6School of Management,University of Saint

Andrews, Scotland, UK

Correspondence

Suxiao Li, Postdoctoral Workstation,

Industrial and Commercial Bank of China,

West Street of Xuanwumen No. 121, Xicheng

District, Beijing, China.

Email: lisuxiao@aliyun.com

Funding information

National Natural Science Foundation of

China, Grant/Award Number: 71273257,

71532013 and 71703182

Abstract

Using data of 65 economies from January 2000 (2008) to

June 2015, we examine the covariates of sudden stops in

fund equity and bond flows. Our results suggest that

global, contagion and domestic factors are all related to

the likelihood of sudden stops. For sudden stops in equity

flows, global factors play a more important role in high‐in-

come economies. For sudden stops in bond flows, global

variables are the most important covariates in emerging

economies, whereas domestic variables play a more im-

portant role in high‐income economies. We also find that

global and contagion factors are correlated to the magni-

tude of sudden stops.

JEL CLASSIFICATION

E32, F30, F32, G15, G23

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LI et aL.

decline of 4% in GDP growth. This collapse in real activity is usually accompanied by increased un-

employment (Rothenberg & Warnock, 2011).

Several papers have examined the “drivers” of sudden stops.1 These studies focus on stops of in-

ternational capital flows. In contrast, this paper examines sudden stops of international fund flows.

International fund flows are cross‐border investments in bond and equity markets by global funds,

including mutual funds, exchange traded funds (ETFs), closed‐end funds, insurance‐linked funds, and

hedge funds (Li, De Haan, Scholtens, & Yang, 2015). They are part of portfolio investments in the

IMF’s balance‐of‐payment classification.2

Most previous research on capital flows focuses on aggregated portfolio flows, examining whether

they are driven by domestic (pull) or global (push) factors (see, for instance, Sarno, Tsiakas, & Ulloa,

2016). As argued by Li, De Haan, and Scholtens (2018), compared with other types of capital flows,

fund flows are more volatile. In addition, fund flows are more susceptible to reversal when investors

get new information. This suggests that fund flows play an important role in the transmission of

shocks (Jinjarak, Wongswan, & Zheng, 2011; Raddatz & Schmukler, 2012). Given the volatility and

the mutability of fund flows, we investigate this particular type of international capital flows.

We address the following research questions: (1) How have sudden stops in fund flows evolved

over time and across countries (countries in this whole paper indicate economies including countries

as well as regions.)? (2) Are they mostly related to domestic (pull) factors or global (push) factors? (3)

Are the covariates of sudden stops the same in high‐income and emerging countries? and (4) What are

the covariates of the magnitude of sudden stops? We use data for fund flows into 65 high‐income and

emerging countries from January 2000 (2008) to June 2015.3 Whereas most studies on sudden stops

employ annual or quarterly data, we use monthly data from the EPFR Global Database (see Section

3). This allows us to estimate the timing of sudden stops more precisely.

We identify four waves of sudden stops in equity flows. The first wave was in 2000 to 2001, while

the second wave occurred from 2007 to 2009 when the world was hit by the global financial crisis

(GFC). The third and fourth waves were in 2011 to 2012 and in 2014 to 2015. We identify three waves

of sudden stops in bond flows, which largely coincide with the last three waves for equity flows (our

data for bond flows start later than those for equity flows). Compared with sudden stops in net capital

flows, we find that sudden stops in fund flows are much more clustered. The peaks of sudden stops

in fund flows are earlier than those of net capital flows, which is in line with the argument that fund

flows respond swiftly to shocks and are more susceptible to reversal when investors get new informa-

tion (Agosin & Huaita, 2012; Levchenko & Mauro, 2007). Our results suggest that global, contagion,

and domestic factors are linked to the likelihood of sudden stops. For sudden stops in equity flows,

global factors play a more important role in high‐income countries, while domestic factors are import-

ant both in high‐income countries and in emerging countries. For sudden stops in bond flows, global

variables are the most important covariates in emerging countries, whereas domestic variables play a

more important role in high‐income countries. Contagion variables are significant in the models for

both subsamples. We also find that the magnitude of sudden stops is primarily correlated with global

and contagion factors.

Our contribution to the literature is threefold. First, to the best of our knowledge this is the first

paper investigating sudden stops in equity and bond fund flows. Second, this paper presents new

evidence on the covariates of the magnitude of sudden stops in fund flows. Third, our results have

some interesting policy implications. For instance, they suggest that financial openness in emerging

countries may reduce the likelihood of sudden stops in bond flows (but not in equity flows), but it is

not related to the magnitude of sudden stops.

The remainder of this paper is structured as follows. Section 2 summarizes related studies. After

introducing the data employed, Section 3 describes the identification of sudden stops in fund flows and