Studies of institutional development, international financial flows and emerging markets

Abstract

This thesis is based on three empirical studies which look into the role of institutions and political risks on the behaviour of cross-border capital inflows and exchange rates. The first empirical study, presented in Chapter 2, investigates the links between political risk and institutional quality features and cross-border capital flows of 28 African economies. Both FDI and bank inflows are considered over the period 1990 to 2014 and it is found that such risk and quality features are much more crucial determinants of FDI as opposed to bank inflows to the African region. Quantile regressions are also employed to provide a more thorough understanding of the effects of these risk and quality features throughout the inflows distributions and it is observed that such effects are nonlinear as they strengthen with the level of investment countries receive, especially FDI investment. These findings are found to be robust when accounting for various domestic and global determinants of capital flows applicable to African economies. The second empirical study, examined in Chapter 3, considers the association between institutional quality and the volatility of FDI and cross-border lending inflows for 43 advanced and developing economies. The fixed-effect method is employed to quarterly data over the period 1995Q1 to 2018Q4 and demonstrate that through many features, strong institutions and low political risk contribute to lower capital flow volatility in both cases. More specifically, religious and ethnic tensions are highlighted as important factors for FDI volatility, while with bank lending we find lower corruption, ethnic tensions and higher bureaucracy quality to be the main aspects to control volatility. With both types of capital flows, increased ethnic tensions stand out as the most crucial factor causing higher volatility and government stability is shown to be the weakest. Overall, this study identifies a robust common pattern between both types of capital flows, implying that policymaking through institutional settings can prove to be an effective collective remedy to increased volatility of capital flows. The third empirical study, explored in Chapter 4, looks at the effects of institutional strength on the movement of real exchange rates of 25 emerging market economies. Using fixed effects method and monthly data over 1995M1 to 2018M12, the findings reveal that improvements in various aspects of institutional quality generate an appreciation of emerging market currencies, providing significant evidence that exchange rates have been driven by factors beyond the conventional macroeconomic fundamentals. These institutional quality contemporaneous effects are found to be reversible when considering their corresponding delayed effects over previous 12 months, since we find evidence that indicators resulting in a contemporaneous appreciation of exchange rates exhibit the reverse delayed effects. This outcome underlines the continuous development of institutions for emerging markets to gain from the long-term appreciation of their currencies.