Why are capital flows so much more volatile in emerging than in developed countries?
One of the most studied subjects in open macroeconomics is what determines capital flows. In general, most papers are concerned with estimating the following regression. where the left-hand side is some measurement of capital flows, either as a percentage of gross domestic product (GDP) or as changes, and the right-hand side introduces several time and cross-sectional controls, such as GDP growth, real exchange rates, the international interest rate, terms of trade, availability of international funds, or some measure of credit constraints. Almost the entire literature focuses on the properties of A, such as the signs and significance of the coefficients and the most important determinants. This paper takes a different perspective: we concentrate on the explanatory power of fundamentals and on the properties of the residuals—that is, the portion of capital flows that is unexplained by fundamentals.