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Capital flight often amounts to a substantial proportion of GDP in developing countries. This paper presents a portfolio choice model that relates capital flight to return differentials, risk aversion, and three types of risk: economic risk, political instability, and policy variability. Estimating the equilibrium capital flight equation for a panel of 45 developing countries over 16 years, all three types of risk have a statistically significant impact on capital flight. Quantitatively, political instability is the most important factor associated with capital flight. We also identify several political factors that reduce capital flight, ostensibly by signaling that market-oriented reforms are imminent.

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This paper considers the role of corruption in impelling capital flight. Identifying corruption as one dimension of poor governance, the empirical analysis explores direct linkages between corruption and capital flight in a broad sample of countries. The novelty of this investigation is that it is based on a portfolio choice model of asset allocation that explicitly recognizes corruption as contributing to the variance of domestic investment risk. The main testable proposition emerging from our theoretical specification is stated thus: does corruption impel capital flight by raising the risk of domestic investment, ceteris paribus? An econometric analysis suggests that, holding other determinants of capital flight constant, corruption does have a positive and significant impact on capital flight. Based on these results, the paper concludes that advocating good governance by combating corruption makes a great deal of sense for countries aiming to staunch capital flight. JEL CLASSIFICATION: G11, F32KEY WORDS: Capital flight, governance, corruption, economic risk Capital flight and corruption are some of the main causes of the poverty in the South. Without capital flight and corruption the debt crisis would not exist in its current form.

This paper presents empirical evidence that links private investment to rate of return differential, risk aversion, and several types of political and economic risk. Estimating private investment equation for a panel of 25 developing countries over 21 years yields the following results: (i) socio-political instability characterized by nonviolent protests promotes private investment while violent uprisings hinder private investment; (ii) regime change instability characterized by constitutional government change promotes private investment while unconstitutional government change hinders private investment; and (iii) policy uncertainty characterized by variability of contract enforcement rights promotes private investment while variability of government political capacity hinders private investment.