International Risk Tolerance, Capital Market Failure and Capital Flows to Emerging Markets

For the past two decades as capital market financing1 for middle-income developing countries, now known as ‘emerging markets’, has expanded enormously, so has the academic literature on the explanations for the evident instability of these flows to and their allocation across these host countries. Most of this literature and the policy debate have centred on macroeconomic stability, market access and institutional arrangements in emerging market economies themselves — that is, on host ‘fundamentals’. Much less attention has been paid by development economists to the nature of the demand schedule, in terms of both level and stability, or emerging market assets on the part of international investors, and in particular the role of ‘home’ market factors in the developed economies. In marked contrast, the professional or ‘market’ literature, including that written by regulators, takes these demand shifts very seriously (FitzGerald 2003).