International Capital Flows and Host Country Political Environment: An Empirical Investigation∗

We investigate to what extent the political environment accounts for differences among capital flows to host countries. We identify political conditions as the common ground underlying the main theoretical explanations of the Lucas paradox. Using a rarely em-ployed dataset of objective measures of political institutions in addition to subjective ratings, we apply extreme bounds analysis to study empirical regularities between po-litical conditions and average inflows of foreign direct investment, portfolio equity and debt across countries from 1984-2003. Our results suggest that detailed analysis of the political environment contributes to our understanding of international equity and debt flows