Fundamentals, Financial Factors, and the Dynamics of Investment in Emerging Markets

Abstract

The paper uses a panel vector autoregression approach to analyze the dynamics of the transition of investment to shocks to fundamental and financial factors in emerging market economies. By relying on a panel of thirty-one emerging economies and quarterly frequency data for the period 1990:1-2008:3, we show that (1) investment sluggishly adjusts to its own shocks; (2) gross domestic product and equity price shocks have a positive and sizable impact on investment; (3) unexpected variation in the cost of capital and the lending rate has a negative effect on investment; and (4) the response of investment to credit market developments seems to be driven by the demand side. In addition, the effects of equity price shocks appear to be similar for emerging Asia and Latin America, but credit shocks are more important in Latin America. Moreover, shocks to the lending rate have a pronounced and negative impact in emerging European markets. Finally, we show that the stock market bubbles may have encouraged real investment during the 1990s.

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