Is Domestic Uncertainty a Local Pull Factor Driving Foreign Capital Inflows? New Cross-Country Evidence

Theory and conventional wisdom suggest that an increase in uncertainty in one country scares
away foreign investment. But, due to the limited availability of cross-country uncertainty data,
empirical evidence remains scarce, and mostly confined to a limited set of countries. This paper
provides a systematic analysis of how foreign capital inflows react to an increase in political and
economic uncertainty, proxied using the World Uncertainty Index. We focus on bank credit,
portfolio debt, and portfolio equity capital inflows into 143 countries from 51 source countries.
We find that an increase in domestic uncertainty induces a substantial and persistent decrease
in bank credit and portfolio debt inflows, and (to a lesser extent) in equity inflows. The effects
on portfolio inflows are larger for countries with more open capital markets. We also uncover
important differences in the response of portfolio inflows through actively-managed versus
passive funds. The formers are similarly sensitive to changes in uncertainty that are countryspecific
(purely local uncertainty) and common across countries (global uncertainty), while the
latter are only sensitive to global uncertainty.