Academic journal article International Advances in Economic Research

Capital Flows to an Emerging Financial Market in Turkey

Academic journal article International Advances in Economic Research

Capital Flows to an Emerging Financial Market in Turkey

Article excerpt


Increased globalization in financial markets implies that the percentage of all shares under foreign ownership in domestic stock markets has been rising. Speculative attacks on the foreign exchange market in February 2001 led to deep economic crisis in Turkey. This article will explore various indicators of the financial crisis in Turkey based on a macro-model. The foreign share of the domestic economy is a key variable to establish the degree of vulnerability during a financial crisis. An empirical investigation shows that the percentage of shares owned by foreigners on the Istanbul Stock Exchange (ISE) has been increasing since 1995 and is currently about 50 percent of the total. Furthermore, the general index of stock market prices in 1999 was at its highest level since 1995. This would imply that the general price index of the stock market is another strong indicator of an impending financial crisis. An empirical investigation of Turkish data based on a theoretical model is presented in this paper. An unexpected capital outflow would certainly cause exchange rate fluctuations, balance of payments problems, and international debt crisis. Hot money inflows boost share prices and keep the real exchange rate high. However, short-term stay of capital implies a sudden capital outflow that creates financial crisis, which results in international debt crisis. This in turn leads to a further increase in loans from the International Monetary Fund (IMF). Relatively high stock market prices may suggest an impending financial crisis. Using Turkish stock market price data, an impending financial crisis can be statistically predicted. (JEL E60, F32, F34, F36, F40, G15)


Much work has been done in the area of financial crisis. Johnson et al. [2000] created a vulnerability matrix using sets of criteria including macro indicators. Other theories of crisis include speculative attacks [ Krugman et al. 1979], and self-fulfilling hypotheses [Obstfelt, 1995]. Other works include fundamentals, the second generations model moral hazard, and self-fulfilling expectations models on liquidity. Krugman [1996], Kaminsky [1998], and Kaminsky and Schumukler [1999] referred to these factors as contagions or common factors affecting all countries.

Experience shows that short-term capital inflow is undertaken in pursuit of quick gains and includes or comprises speculation in the exchange rate markets. The result is increasing international debt and the possibility of the halving of national wealth overnight, as happened in Turkey early in 2001. Most analyses are based on flow variables alone and ignore the effects of financial crisis on stock variables such as international indebtedness and wealth. Recent IMF papers by Borensztein [2000] and Lane Milesi-Ferretti [2000] underline the importance of linking theory with empirical work on real exchange rates and indebtedness. The possibility of unstable long-run equilibria based on our theoretical model is usually ignored in these studies (whereas the possibility is taken as given here).

The arguments in this paper are based on a theoretical model that is different from others. The author argues that probability of future volatility is closely related to the percentage of shares under foreign ownership in the domestic stock market and the volatility of stock market prices.

This paper is ordered as follows: section two presents a summary of the model. Section three is an investigation into foreign share ownership on the Istanbul Stock Exchange and the forth section is a report on the empirical results. Section five concludes.

Theoretical Model

The model is based on Gazioglu [2001] and Gazioglu and McCausland [2001; 2002], with a profit maximizing firm and a representative domestic consumer maximizing time separable utility functions [Obstfeld and Rogoff, 1995; Ramsey, 1928]. Following Obstfeld and Rogoff [1995], the stock market constraint is as follows:

(1) [V. …

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