The Dynamics of Emerging Market Equity Flows

We study the interrelationship between capital °ows, returns, dividend yields and world interest rates in 20 emerging markets. We estimate a vector autoregression with these variables to measure the degree to which lower interest rates contribute to increased capital °ows and shocks in °ows a®ect the cost of capital among other dynamic relations. We precede the VAR analysis by a detailed examination of endogenous break points in capital °ows and the other variables. These structural breaks are traced to the liberalization of emerging equity markets. Our evidence of structural breaks calls into question past research which estimates VAR models over the full sample. After a liberalization, we ̄nd that equity °ows increase by 1.4% of market capitalization. We also show that shocks in equity °ows initially increase returns which is consistent with a price pressure hypothesis. While the e®ect is diminished over time, there also appears to be a permanent impact. This is consistent with our ̄nding that our proxy for the cost of capital, the dividend yield, decreases. Finally, our analysis of the transition dynamics from pre-liberalization to post-liberalization suggests that when capital leaves, it leaves faster than it came in. These results may help us understand the dynamics of the recent crises in Latin America and East Asia.