Financial openness and cross-border capital flows: perspectives from terrorist attacks as exogenous shocks

In an era of financial globalization, cross-border capital flows hugely affect a country’s economic conditions, but their cyclical properties remain controversial. This paper takes terrorist attacks as exogenous shocks to study whether financial openness helps an economy recover from a crisis through inducing capital inflows, or amplifies the adverse effects by allowing for capital flight. With a panel dataset from 1990 to 2016, we show that cross-border capital flows are largely pro-cyclical, especially for non-OECD countries. A higher level of financial openness is associated with net capital outflows in response to terrorist incidents, mainly due to the decrease of the aggregate capital inflows by foreign investors. This mechanism also applies to disaggregate cross-border capital flows such as FDI, portfolio investment and debt investment. Furthermore, there is no sign that exchange rate adjustment insulates non-OECD countries from net capital outflows following a terrorist attack.