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Policy Uncertainty and Cross-Border Flows of Capital

Brandon Julio, LBS

16th Sep 2011  11:30 am - 12:30 pm Room 214/215 H69

We find that policy uncertainty is an important determinant of fluctuations in cross border flows of capital.

Specifically, we find that fluctuations in policy uncertainty around national elections generate cycles in cross-border flows around the world. FDI flows from US companies to foreign affiliates drop significantly when there is a national election in either the US or the destination country. The election patterns in foreign direct investment are more pronounced in countries with lower measures of government stability and a lower degree of checks and balances in the political system. We also find that elections with more uncertain outcomes lead to larger swings in the DFI flows. The electoral cycles in cross-border capital flows are limited to investments that are relatively irreversible.That is, we find that capital flows are sensitive to policy uncertainty in both high and low-income counties, suggesting that political uncertainty is not only an emerging market phenomenon. These results suggest that policy uncertainty acts as a tax on cross-border investment.