Abstract:
Global monetary policy, financial risk and risk aversion are important determinants
of international capital flows. Capital flows may in turn cause expansion of credit
and leverage in the recipient economy. This PhD thesis contributes to our understanding
of the transmission channel from global risk factors to domestic credit and
saving. We estimate the time varying effects of risk on portfolio flows to South Africa,
we estimate the transmission of portfolio flows to credit, and lastly we incorporate
our empirical findings in a two-country DSGE model with portfolio flows and risk
constrained financial intermediaries.
Risk and risk aversion are found to affect bond and share flows to South Africa
differently. Risk consistently affects bond flows more than share flows. The relationship
between risk and portfolio flows is also found to be continuosly evolving and
highly dependent on the macroeconomic environment.
We further study the transmission channel linking portfolio flows to credit extension
in South Africa. We posit that the transmission works by increasing banks
supply of credit and we find empirical support for this hypothesis. Parts the proceeds
from portfolio flows are deposited in local banks. This cash injection increases banks
supply of credit and the effect is pro-cyclical. If the cash is injected during a credit
expansion it will have a stronger effect on credit extended. We find that share flows
tend to cause more cash injections than bond flows and are therefore more prone to
cause credit expansions.
The empirical findings guide our construction of a two-country DSGE model with
financial intermediaries and macroprudential policy. The model shows that portfolio
flows arise from changes in asset demand from foreigners relative to demand from
residents. Simulations show that risk shocks affecting both emerging market and
foreign investors will cause demand for emerging market bonds to shift from the
foreign to the local investor, causing an outflow in the emerging bond market. Both
the foreign and domestic investors will cut demand for shares, and therefore the
direction of share flows is unpredictable. Shocks to risks that are only carried by
foreign investors cause stronger portfolio flows out of emerging market shares. The
global policy environment has a great impact on the transmission of global shocks to
portfolio flows. Bond supply can absorb risk shocks, while interest rates can absorb
income shocks. Tighter macroprudential policy in the recipient economy has very
limited, if any, effect on the relationship between portfolio flows and domestic credit
extension.
