The Impact of Hot Money on the Korean Financial Markets

Abstract

Sudden outflow of hot money makes the financial system of the emerging economies unstable and, sometimes, results in financial crises or severe recessions. That is why the governments or regulators keep a close watch on the dynamics of hot money flow. This paper investigates the effects of the hot money flow on the Korean financial markets using a regime-dependent parameter model. The effects of hot money on each financial market are allowed to be dependent on the different volatility regimes. We utilize the Bayesian MCMC (Markov chain monte carlo) methods to estimate both the regimes and the regime-dependent effects of hot money. We find that the hot money flow has some direct effects on the exchange rate and the government bond yield even though we control other financial variables. In addition, the hot money flow turns out to have bigger effects on the financial markets during the high volatility regime than the low volatility regime. The Asian financial crisis in 1997-98 and the global credit crisis in 2008-09 are estimated to be the high volatility regimes for all the financial markets. But the durations of the high volatility regimes turn out to be different among the financial markets.