Spillover effects of capital controls on capital flows and financial risk contagion

Abstract This paper aims to explicitly investigate the multilateral effects of capital controls on capital flows and the risk contagion from global financial shocks to emerging market economies (EMEs). Using a comprehensive portfolio allocation data set from EPFR and a newly constructed high-frequency similarity-weighted average capital control (SWACC) index of the rest of the world in 19 EMEs from 2001 to 2015, this paper then empirically explore the spillover effect of capital controls on capital flow and capital price co-movement. We find that SWACC is positively associated with the global fund's portfolio weight allocated to a country, the total portfolio flows into that country, and the capital market co-movement between that country and the advanced countries. Further analysis shows that these impacts are more pronounced for capital inflow control or, in extreme circumstances, when capital flows are extremely high or low. Our results are robust to a variety of alternative measures, regression designs, and methods.