IRIS Summary Working Paper No. 104

In some less-developed countries or regions, we observe periods of very large capital inflows alternating with periods of very large capital outflows. What accounts for this volatility? We develop a model based on the interaction of persistent, stochastic swings in the profitability of local investment on the one hand, and of forward-looking investment behavior (due to irreversibilities) on the other. We suggest that government policy responses may well magnify the effect of technological uncertainty and thus be responsible for the wide observed swings of capital accounts in regions such as Latin America. * Bertola gratefully acknowledges financial support from the National Science Foundation