Volatile Capital Flows and Financial Stress in Emerging Economies

In this paper, we examine the links between the volatility of capital flows and financial stress in emerging economies. In particular, we explore whether macroprudential policies mitigate the exacerbating effects of capital flows volatility on financial stress. Using cross‐country data from 2010Q1 to 2022Q4, we find that the volatility of capital flows can drive up domestic financial stress. The findings hold for both aggregate capital flows and its various components, and for both directions. Macroprudential policies weaken the level of financial stress by dampening the exacerbating impact of volatile capital flows, except for portfolio investment. The results indicate that more effective policies need to be designed to regulate portfolio investment and ensure financial stability in emerging economies.