Fixed Investment and Capital Flows - A Real Options Approach

by Peter B. Clark

International capital flows often appear to be subject to sudden changes in sentiment. This is most clearly the case in episodes of speculative attacks against fixed or quasi-pegged exchange rates, such as occurred in the ERM in 1992-93, Mexico in 1994-95, and in many Asian emerging markets in 1997-98.2 Much of the analysis of episodes of this kind identifies shifts in economic fundamentals or self-fulfilling speculative bubbles as underlying the change in sentiment generating the fluctuations in capital flows.3 However, another perspective on the episodic nature of the movement of capital internationally can be obtained by looking at the factors underlying the timing of domestic investment and the capital flows that may be associated with the change in the capital stock. Exploring the link between real investment and capital flows can bring out the value of waiting before implementing a decision to invest, and therefore provide an alternative explanation for the sudden movements in capital flows.

29 pages, Kindle Edition

First published August 1, 1998