Dynamic Capital Mobility in Pacific Basin Developing Countries
Estimation and Policy Implications

This paper estimates empirically the changing degree of capital mobility in several Pacific Basin countries that have pursued financial liberalization in recent years. Tracing the impact of the liberalization process on the capital account, the paper also examines the implications for monetary policy operating in this changing economic environment. Empirical estimates support an overall finding of increased capital mobility in the region over the past decade. However, country experiences, with the exception of Singapore, have been more episodic--oscillating between periods of high and low financial openness--rather than uniform in regards to changing capital mobility.

Abstract

This paper estimates empirically the changing degree of capital mobility in several Pacific Basin countries that have pursued financial liberalization in recent years. Tracing the impact of the liberalization process on the capital account, the paper also examines the implications for monetary policy operating in this changing economic environment. Empirical estimates support an overall finding of increased capital mobility in the region over the past decade. However, country experiences, with the exception of Singapore, have been more episodic--oscillating between periods of high and low financial openness--rather than uniform in regards to changing capital mobility.

I. Introduction

Recent experience among developing countries in the Pacific Basin has been, in part, a continuing process of financial market liberalization and growing financial flows over the past decade. Although particular liberalization measures have varied across countries, the region as a whole has seen a general trend toward deregulation of domestic financial markets and the removal or relaxation of many restrictions on international capital movements. Though country experiences regarding net resource flows have also differed, 1/ the trend here has been a declining proportion of external borrowing and an increasing share of private resource flows in total external liabilities among these countries.

As financial liberalization continues in the region, the empirical question remains as to the impact of these developments on the level of integration between local and world financial markets. In particular, observing the changing degree of capital mobility -- defined broadly in this context as the degree of linkage between domestic and foreign interest rates -- is of special concern to the small open economy attempting to stabilize its exchange rate, but facing ever increasing and responsive financial flows. Moreover, to the extent that monetary transmissions work through real interest rates, the ability of the authorities to independently pursue domestic stabilization objectives also becomes increasingly suspect with the opening of the capital account.

Most of the empirical work done in this area has examined capital mobility from a static perspective, estimating either an offset or an openness coefficient. For example, Edwards and Khan (1985) have developed an analytical framework for interest rate determination in developing countries wherein the prevailing interest rate represents a weighted average of open and closed economy rates that otherwise would have existed. Estimation of this weight indicates the relative importance of interest rate parity and domestic monetary factors in determining national interest rates, thus capturing the degree of financial openness. More accurately, however, this approach estimates the average degree of openness for a given country over the sample period. Hence, this line of research essentially eludes the question of the changing degree of capital mobility and, consequently, the changing roles of stabilization and exchange rate policies over time. 2/

To assess the impact of the financial liberalization process on the mobility of capital and the role of policy through time, a dynamic modelling approach is needed. The technique employed in this paper involves Auto-regressive Conditional Heteroschedasticity (ARCH) estimation of interest rate differentials between select Pacific Basin developing countries and Japan. 1/ Our purpose is to determine the extent to which these interest rates have become increasingly interrelated. Specifically, dampened deviations from trend in interest rate differentials reveal an increased level of capital mobility, and time series estimation of this process details the timing and magnitude of those changes. From determining the dynamics of capital mobility, we then turn to the implications for monetary policy operating in this changing economic environment.

The paper is organized as follows. Section II begins by summarizing briefly some theoretical background on interest rate parity in the presence of various adjustment costs such as capital controls and transactions costs. An appendix is included that integrates our discussion on imperfect capital mobility in section II into a dynamic model following Dornbusch (1976) to structure the econometric analysis in section III. Finally, section IV extends the time series results of section III to policy issues by simulating impulse-response functions using country parameter estimates.

II. Theoretical Background

1. Interest rate parity

A central tenet in open economy macroeconomics is the theory of interest rate parity (IRP). A covered version of the theory equates the forward discount/premium with the difference between domestic and foreign interest rates. This equality can be interpreted as an arbitrage condition, indicating that covered profit opportunities have been fully exploited. Explicitly, we can express this interest parity relation in a general form by:

φ̲=iifd,(2.1)

where ϕ̲ represents the covered interest rate differential, i and i* are the domestic and foreign interest rates for a given maturity, and fd is the forward discount - equaling (F-S)/S, where F and S are the forward and spot exchange rates (expressed as home currency price of foreign currency). Time subscripts have been suppressed here for notational convenience. With risk neutral speculators and perfect substitutability of assets, the covered differential ϕ̲ should be identically zero under IRP in the absence of any distortions or frictions such as capital controls or transactions costs.

In a stochastic setting, we can set an error term equal to (2.1), allowing ϕ̲ to vibrate randomly around zero up to an white-noise disturbance term ϵ̲. That is, the contemporaneous disturbance terms ϵ̲t’s are restricted to be independent and identically distributed (i.i.d.), mean zero, and unforecastable at time t. Otherwise, unexploited profit opportunities would exist, violating our basic arbitrage condition. Perfect capital mobility is often defined as (2.1) when set to zero. However, one should be careful to note that this representation also embodies assumptions on risk preference and asset substitutability.

2. Imperfect capital mobility

Adding various frictions, such as information and transactions costs, we can modify the simple case of perfect capital mobility. Rather than strict equalization of domestic and covered foreign rates of return, interest rate differentials may exist within some neutral band 1/:

|φ̲=iifd|<AC,(2.2)

where AC represents the sum of the various adjustment costs, in percentage terms, involved in moving funds through domestic and foreign asset markets via the foreign exchange market. Appending the basic arbitrage condition with costs of adjustment also relaxes the white-noise constraint on the disturbance term ϵ. Equation (2.2) now permits φ to systematically deviate within the band while still excluding arbitrage profit opportunities. Treating capital controls as another form of adjustment cost 2/, we can increase the band-width in (2.2) to AC’ > AC, capturing the additional costs of relocating arbitrage funds in the presence of official restrictions, including such regulations as differential taxation, foreign exchange controls and so on.

3. Risk aversion, uncertainty, and imperfect asset substitutability

Relaxing our initial assumptions in the case of perfect capital mobility by allowing risk aversion in speculators, along with the non-comparability of assets, modifies (2.2) even further. For example, capital controls introduce more than just the “certainty” or direct costs associated with existing controls. Otani and Tiwari (1990) argue that their presence exerts “uncertainty costs” as well, concerning future capital restrictions. Such considerations introduce differences in underlying risk characteristics of assets, reducing the supply elasticity of capital. Using expected utility and mean-variance optimization, Otani and Tiwari (1990) show the impact of uncertainty associated with capital controls on the IRP relation as follows:

|φφ¯|<AC,(2.3)

where AC ″ (> AC) incorporates the implicit costs associated with existing capital controls, and where φ¯ is the risk premium indicating that the (broader) neutral band is no longer symmetric about zero. In general, capital controls are merely one aspect of political or country risk that may drive a wedge between various rates of return and reduce the responsiveness of capital to arbitrage return differentials. Note that non-comparable risk in assets in various financial markets, which places these rates of return in disparate risk classes, may remain even in the absence of any other impediments to interest rate parity. Moreover, economic liberalization measures that do not even affect financial markets directly may still impinge upon perceived differences in asset risk characteristics, affecting departures in interest rate parity.

Although not exhaustive, this list gives some sense of the many frictions and distortions that possibly preclude our original interest parity relation empirically. As for the impact of financial market liberalization, resultant changes in various adjustment costs and/or asset substitutability should directly affect the size of the neutral band wherein return differentials may systematically deviate. Specifically, liberalization measures that effectively increase financial openness will narrow the implicit band. Increasingly confined, IRP deviations will thus reflect the reduced impact of domestic monetary factors in determining domestic interest rates resulting from a heightened responsiveness of internationally mobile capital. Furthermore, the centrality of the band may also be affected by increasing financial market integration as captured by a diminishing risk premium, stemming from greater asset substitutability. Introducing imperfect capital mobility formally into a sticky-price model following Dornbusch (1976) is relegated to the appendix.

III. Time Series Estimation

1. Interest rate data

Monthly data series on domestic money market interest rates were obtained for the following Pacific Basin countries: Korea, Singapore, Malaysia and Thailand. 1/ For comparison, the three-month London Interbank Offer Rate (LIBOR) on Japanese Yen deposits was chosen to represent the world rate of interest. By choosing an offshore rate as the reference point, we intended to limit the influence of liberalization measures taken in Japan in order to isolate the impact of measures taken domestically on interest rate convergence.

Series on interest rate differentials were then constructed by subtracting the Japan LIBOR from the domestic rate, or φ̲t=(ii)t, expressed in annual percentage terms. Assuming exchange rates versus the Yen follow a random walk for our sample countries, 1/ we may relate these interest rate differentials with a suitably defined interest rate parity condition, in an attempt to calibrate deviations from the latter as a measure of capital mobility.

Initial non-parametric statistics for φ consisting of sample means and variances were computed and are given below in Table 1. The full sample period from 1978:9 to 1990:12 was also sub-divided in half with descriptive statistics for each subsample period appearing in columns 3 through 6. Note that for every country in our sample, mean interest rate differentials were smaller in absolute terms in the second half of the period than the first. The same fact holds true for sample variances as well. Also note that risk premia appear to be significant for Thailand and Korea, but relatively insignificant in the case of Singapore and Malaysia.

Table 1-

Non-Parametric Estimates: Interest Rate Didfferentails in the Pacific Basin

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Data Source: IMF International Financial Statistics and IMF Staff

2. ARMA Estimation

To analyze deviations from interest rate parity, we must first characterize the motion of interest rate differentials by using univariate time series estimation. Here, we apply an Autoregressive Moving Average (ARMA) representation to φ̲t, including a constant and a non-linear time trend. 1/ Introducing a constant allows for the presence of a risk premium, implying a non-zero, long-run value of φ. ARMA specification with a trend permits us to separate systematic deviations about IRP, which reflect the degree of capital mobility, from movements in the IRP value itself, which reflect changes in asset substitutability. Although, these two issues are not unrelated.

As for estimation, an ARMA(p,q) model for demeaned and detrended interest rate differentials - representing IRP deviations - can be written generally as:

A(L)(φtμtrendt)=B(L)ϵt,(3.1)

where A(L) and B(L) are respectively the AR and MA lag polynomials of orders p and q, written as A(L) = 1 - λ1L - … - λpLp and B(L) = 1 + γ1L + … + γqLq with L representing the lag operator, and where μ is the constant term. Using this general framework, Ordinary Least Squares (OLS) and Non-linear Least Squares (NLLS) estimates for φ - - in versions containing a constant, trend or MA errors -- were computed. Estimation results for the coefficients are reported below in Table 2.

TABLE 2.

ARMA Estimation: Interest Rate Differentials in the Pacific Basin

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From Table 2, note that an AR(1) specification was chosen as the appropriate time series representation for interest rate differentials in Singapore, Korea and Thailand, while an ARMA(1,1) model was selected in the case of Malaysia. So for example, from Table 2, we see that the time series behavior of interest rate differentials in Malaysia is best represented by the univariate model Φt = .9373Φt−1 + ϵt -.4381ϵt−1. Selecting the particular order of the model -- that is, the number of AR and MA lags -- for each country was completed using the Schwarz Information Criterion (SIC). 1/

Constants were found statistically significant only for Thailand and Korea and elsewhere omitted. Also, a time trend was found to be significant in the case of Korean interest rate differentials. All ARMA coefficients implemented were found to be highly significant at the. 01 level or better. The large estimates for the coefficient λ1 (close to 1) on lagged interest rate differentials Φt−1 suggest weak mean-reverting behavior in the data and significant persistence in deviations from interest rate parity, especially in the case of Malaysia and Thailand. 2/

Plots of interest rate differentials φ and residuals from ARMA estimation are seen for each country in Charts 1 through 4. Close inspection of residuals for Singapore in Chart 1 reveals strong support for the notion that shocks to and, hence, deviations from IRP have diminished over the 1980s, suggesting increased capital mobility. Large impulses to IRP deviations typified most of the early sample period from 1979 through 1982, but disturbances have shown sustained dampening ever since.

Chart 1
Chart 1

Singapore versus Japan LIBOR

Interest Differentials, 9/1978–12/1990

Citation: IMF Working Papers 1991, 115; 10.5089/9781451853834.001.A001

Malaysia has seen such dampening only more recently, since 1987, as evident in Chart 2 residuals. Preceding this quiet period, a turbulent episode of large deviations existed from mid-1984 to 1987 in return differentials, although much of this volatility was attributable to a few isolated shocks. Sustained variability of disturbances to IRP, indicating limited capital mobility in Malaysia, was only evident in the beginning of the period (1979 to mid-1982) and has since subsided in accordance with increased financial integration, with the one exception occurring in the mid-1980s.

Chart 2
Chart 2

Malaysia versus Japan LIBOR

Interest Differentials, 9/1978–12/1990

Citation: IMF Working Papers 1991, 115; 10.5089/9781451853834.001.A001

As for Korea, the most dramatic development regarding financial liberalization and IRP over the 1980s has been an enormous decline in average interest rate differentials as captured by the trend in Chart 3, reflecting increased asset substitutability and a time-varying risk premium. As for capital mobility, variance of disturbances to IRP in Korea have shown a sustained decline through most of the sample period, but have more recently reverted in terms of variability since 1988.

Chart 3
Chart 3

Korea versus Japan LIBOR

Interest Differentials, 9/1978–12/1990

Citation: IMF Working Papers 1991, 115; 10.5089/9781451853834.001.A001

The results for Thailand are less clear. Chart 4 portrays numerous episodes of relative tranquility and turbulence in Thai interest rate differentials. Without a clear tendency toward dampened deviations in φ, evidence for increased financial market integration in Thailand appears ambiguous, in contrast with the experience elsewhere in the region.

Chart 4
Chart 4

Thailand versus Japan LIBOR

Interest Differentials, 9/1978–12/1990

Citation: IMF Working Papers 1991, 115; 10.5089/9781451853834.001.A001

However, one overall similarity can clearly be drawn. In each country’s experience without exception, large and small residuals, respectively, have generally clustered together. And in most cases, consistent with progressive liberalization, periods of large variability in shocks have preceded periods of dampened shocks. This observation strongly suggests that an Autoregressive Conditional Heteroschedasticity (ARCH) framework -- which models an underlying pattern to the changing variance of residuals -- may be appropriate in order to improve our initial estimates and to further illustrate the systematic changes in IRP deviations and capital mobility in the Pacific Basin.

3. ARCH estimation

The purpose of this section is to formally test for the presence of ARCH residuals and revise our original estimates through ARCH estimation where appropriate. Following Engle (1982), we may represent errors following a nth order ARCH process as:

ϵtN(0,ht);ht=h(ϵt1,ϵtn,α),(3.2)

where ht is the conditional variance function at time t and α is a vector of unknown parameters. Also in (3.2), we have assumed normality. In the presence of ARCH errors, it can be shown in our model that OLS estimators are consistent, but that the standard errors are not.

To correct for conditional heteroschedasticity, we employ Maximum Likelihood Estimation (MLE) to our data series. From (3.2), the log likelihood function for the tth observation can be written as follows:

t=.5loght.5ϵt2/ht.(3.3)

Maximizing (3.3) with respect to the vector of parameters α, λ, μ (constant) and τ (time trend coefficient) will then provide ARCH-corrected estimates. As discussed in Engle (1982), the MLE approach generates consistent estimation of the variance-covariance matrix and asymptotically efficient parameter estimates.

To implement ARCH estimation of φ, we proceed in two steps. First, using residuals obtained from our previous ARMA procedure, we apply a Lagrange Multiplier or ARCH test to check for the presence of ARCH residuals and to determine the appropriate linear specification for ht, 1/ written generally as:

ht=α0+α1ϵ2t1++αnϵ2tn.(3.4)

Second, once a suitable ARCH model has been selected, MLE estimates are computed through iterative search, using ARMA estimates as initial starting values. Under sufficient regularity conditions, the non-linear iterative solution will yield optimal MLE parameter values.

ARCH estimation results are given for each country in Table 3 with the exception of Malaysia. 2/

Table 3.

ARCH Estimation: Interest Rate Differentials in the Pactific Basin

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From the last column in Table 3, notice that the presence of ARCH-type residuals was statistically significant in every case that the ARCH test was applied. In the previous column, the relevant conditional variance function ht, corresponding to these test statistics, can be seen for each country. A first-order ARCH process was found significant in Thailand residuals, while third-order processes describe the behavior of estimated residuals in Singapore and Korea. The revised coefficient estimates and residuals from the ARCH estimation are used extensively when impulse-response functions are simulated in the next section.

But before discussing policy implications, let us reinterpret the results obtained from time series estimation of interest rate differentials in terms of dynamic capital mobility. First, note that the conditional variance function ht represents systematic changes in the variability of disturbances which underlie interest rate disparities. Departures from IRP essentially reflect the degree of linkage between interest rates by capturing the extent to which those rates of return may diverge. Consequently, the changing degree of capital mobility is characterized by the underlying pattern of conditional heteroschedasticity in disturbances effecting IRP deviations.

Chart 5 summarizes our estimates of changing capital mobility in the Pacific Basin by tracing the variation of shocks to interest rate parity. With residuals from ARCH estimation, sample values of ht were calculated and taken as annual averages. In viewing Chart 5, note that movement down along the vertical axis toward the origin indicates increasing capital mobility.

Chart 5
Chart 5

Regional IRP Deviations

Conditional Variance Averages

Citation: IMF Working Papers 1991, 115; 10.5089/9781451853834.001.A001

As mentioned, Singapore appears to have experienced uniform decline (increase) in conditional variance (capital mobility) over the 1980s, leveling off around 1983. Korea’s experience with increasing capital mobility was similar to Singapore’s except for an apparent reversal in direction in the latter part of the decade, although that may be explained in part by the upward pressure on domestic rates in Korea due to inflation related to recent circumstances in the current account. 1/ Thailand showed several episodes of increasing and decreasing financial openness in the 1980s without a clear tendency toward either direction.

For Malaysia, graphing a moving average of ARMA residual variances would reveal a path similar to Singapore’s with the notable exception of a large rise in volatility in the middle years (1984–86) similar to the concurrent experience in Thailand as seen in Chart 5. Not surprising, this volatile episode in return differentials coincides with a period of severe financial crisis in both these countries.

IV. Policy Implications

1. Impulse-response simulations

Translating the variability of IRP deviations into a measure of capital mobility leaves implications for policy less readily apparent as, say, an openness or offset coefficient. To better understand policy implications based on our calibration of capital mobility, we construct impulse-response functions from the time series estimates in section III to simulate the dynamic effects of domestic monetary shocks on interest rate parity deviations. Integrating the changing variability of IRP disturbances into the estimated time series structure completes our representation of the degree of capital mobility. 2/

For Singapore, Korea and Thailand, the estimated conditional variances summarized in Chart 5 were used to model the endogenous response of interest rate differentials with Japan’s LIBOR to a “typical” economic disturbance in 1980 and in 1990. Specifically, using ARCH parameter estimates and the variance functions for each year respectively, we track the effects of a one-time, one standard deviation shock occurring in the first period. 1/ With normally distributed shocks but differing variances at each moment, we need compare the effects of an equally likely disturbance in each year -- here, the likelihood of a one-standard deviation impulse -- to measure relatively the changing impact of domestic economic factors on interest rate parity.

The impact of dynamic capital mobility is clearly evident in Figures 1-4 through comparison of the resulting IRP deviations. Deviations are given as departures from trend or long-run IRP values where amplitude is measured in annual percentage points and persistence is measured in months.

Figure 1
Figure 1

Singapore: Impulse-Response Simulations with ARCH Estimates

Citation: IMF Working Papers 1991, 115; 10.5089/9781451853834.001.A001

Figure 2
Figure 2

Malaysia: Impulse-Response Simulations with ARMA Estimates

Citation: IMF Working Papers 1991, 115; 10.5089/9781451853834.001.A001

Figure 3
Figure 3

Korea: Impulse-Response Simulation with ARCH Estimates

Citation: IMF Working Papers 1991, 115; 10.5089/9781451853834.001.A001

Figure 4
Figure 4

Thailand: Impulse-Response Simulations with ARCH Estimates

Citation: IMF Working Papers 1991, 115; 10.5089/9781451853834.001.A001

The initial impulse may represent, among other things, a negative shock to money demand or a positive disturbance to money supply in the domestic financial market, ceteris paribus. However, since the simulations trace the path of local market return differentials vis-à-vis a world rate, an alternative interpretation for our impulse-response experiment is that of a shock occurring abroad and effecting a response domestically.

If interpreted as a domestic monetary expansion, the impulse-response simulations in Figures 1 through 4 illustrate the empirical analog to the theoretical time-path for φ depicted in Appendix Figure A3. An open market purchase of government securities, for example, would depress domestic interest rates given some price stickiness, opening up a gap between local rates of return and the exogenous world rate. Eventually, imperfectly mobile capital responds to the return differential to close the spread, in this case, with a capital outflow from the domestic economy. With financial liberalization and increased capital mobility over time, the extent to which rates of return may diverge diminishes as return differentials induce a larger offsetting market response.

From Figure 1, we see a monetary expansion in Singapore would initially create a return differential of little more than one-half percentage point in 1990 (dashed line), but nearly a 2-percent interest rate disparity a decade ago (solid line). As for persistence, the deviation from interest rate parity essentially lasts approximately between 3 and 4 quarters in 1990, and between 4 and 5 quarters in 1980.

The changing magnitude of IRP departures over the decade is even more pronounced in the case of Malaysia as seen in Figure 2, with shocks originating disparities of one-half and greater than 2 percentage points respectively at each moment. 1/ The negative MA coefficient from time series estimation of φ for Malaysia is also evident in Figure 2 by the large reversal of the initial shock in the ensuing period before a very lengthy, gradual decay. In fact, convergence in rates of returns following a disturbance is much more gradual in Malaysia than in Singapore, signifying weaker mean-reverting behavior in Malaysian IRP deviations.

For Korea in Figure 3, first note that the impulse-response paths measure departures from an underlying trend similar to the one depicted in Chart 3. Thus, in this case, we have a different time path for interest rate differentials which includes the trend versus interest parity deviations which are detrended quantities. In comparing the responses of the Korean economy to a domestic monetary disturbance in 1980 and in 1990, we notice some dampening in IRP deviations indicative of increased capital mobility. This result obtains despite, as previously mentioned, the apparent increase in variability of residuals -- which translates into a decrease in financial openness -- that occurred in Korea towards the end of the decade (see Chart 5).

Like Korea, Thailand’s simulated departure from interest rate parity in Figure 4 characterizes a deviation from trend, which in this case is a constant or horizontal line. Thailand shows a similar degree of persistence in the effects of monetary disturbances on return differentials as seen in Malaysia. However, in sharp contrast with the other countries, Thailand does not exhibit noticeably the dampening of shocks between 1980 and 1990 that would correspond to increased capital mobility. But, as is clear from Chart 5, this result is contingent upon which episode we draw from.

2. Summary and extensions

Financial market liberalization in the Pacific Basin seems to have had a significant impact on the region’s economic and financial environment over the past decade. Time-varying estimation of return differentials provides strong support to the notion that liberalization measures have raised the level of integration between domestic and international financial markets. Correspondingly, increased capital mobility in the Pacific Basin has effected an increased degree of linkage between regional and world interest rates. As these rates of return have converged across markets, the ability of independent monetary policy to affect real economic activity through domestic interest rates has been reduced.

With fixed or managed exchange rates - - the predominant case in the Pacific Basin -- and responsive capital flows, changes in the domestic money supply and interest rate are reversed more swiftly, leaving monetary policy in the form of interest rate targeting as increasingly unmanageable. 1/ Consequently, heightened capital mobility requires the small, open economy to import to a greater extent its interest rate from abroad, representing international financial conditions. Also, the ability to maintain a fixed exchange rate becomes a tenuous proposition under the weight of heavier capital flows and speculation, reacting to smaller return differentials.

But even with flexible exchange rates and monetary autonomy, return differentials are still dampened resulting from increased financial integration and capital mobility. In this case, though, sensitive capital flows impact largely on the exchange rate to keep interest rates in line through the current account and inflation. Thus, monetary policy gains effectiveness through a new channel of transmission -- the exchange rate, but the tighter interrelation between local and world rates of return remains.

Although the empirical findings suggest an overall trend toward convergence in selected domestic interest rates with the Japanese offshore rate, increased interrelation among other local rates of return with foreign rates is guaranteed only to the extent that domestic financial markets are not segmented internally. That is, our discussion of increased integration between local and world markets presupposed financial integration within the domestic market itself. If there exists signifcant financial segmentation within the home country, estimation of interest rate differentials as a measure capital mobility will be sensitive to the choice of domestic interest rate. 2/

To test for robustness of the findings presented here, a natural follow up would be to include a wider menu of domestic financial assets and repeat the econometric techniques outlined in section III. Choice of a different foreign rate like the U.S. LIBOR 1/ is another empirical alteration of interest. A second type of modification that could possibly sharpen our results would be to incorporate exchange-rate risk explicitly into the time series data, using either the forward or spot rate. If efficiency in the foreign exchange market has significantly changed in conjunction with other asset markets, adding that extra information will strengthen the conclusions. With any of these extension, the same general econometric approach to measurement of dynamic capital mobility that we have developed here would readily apply.

Dynamic Capital Mobility in Pacific Basin Developing Countries: Estimation and Policy Implications
Author: Mr. Hamid Faruqee