DP17012 News, Sentiment and Capital Flows

Author(s): Kenza Benhima, Rachel Cordonier
Publication Date: February 2022
Keyword(s): Asymmetric information, Capital Flows, Expectations, SVAR
JEL(s): D82, E32, F32
Programme Areas: International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=17012

We examine empirically the effect of two types of shocks related to expectations - "news" (increases in expected future productivity) and "sentiment" (surges in optimism unrelated to future productivity) - on gross capital flows. These two shocks together explain more than 80% of the variation in gross capital flows at all horizons, with the largest part being due to sentiment shocks. Both shocks drive a positive correlation between gross inflows and outflows but only sentiments shocks generate procyclical gross flows. We show that sentiment shocks are not accounted for by financial, monetary or uncertainty shocks, nor are they purely global. The empirical effect of news and sentiment shocks constitute a challenge to most theories of capital flows, but are consistent with the existence of asymmetric information between domestic and foreign investors about the country's fundamentals.