Facing Volatile Capital Flows: The Role of Exchange Rate Flexibility and Foreign Assets

In this paper we study the role played by capital controls (CC), the flexibility of the exchange rate regime (FERR) and the stock of assets held abroad (AA) in reducing the volatility of capital flows. First, following Forbes and Warnok (2012), we study the impact of CC, FERR and AA on the probability of stops and surges of gross capital inflows. We find that FERR reduces the probability of a stop, but CC and AA have no impact. Second, we look at their role in facilitating an offsetting event on outflows (a retrenchment or a flight) to an event on inflows (a stop or a surge, respectively). We find that both FEER and AA increase significantly the probability of a retrenchment occurring when a stop has taken place; while lower CC increases the probability of a flight in the event of a surge. Finally, we look at the extent at which funds lost (gained) in a stop (surge) are compensated by funds gained (lost) in a retrenchment (flight). We find that FERR remain the most significant policy tool behind the compensation of stops, as well as CC is for the compensation of surges.