The authors study exogenous capital flow shocks from global mutual funds with a country-level analysis of 25 emerging market countries and data obtained from Emerging Portfolio Fund Research (EPFR). They perform a firm-level analysis of firms in China and India, using the Kaplan and Zingales (Quarterly Journal of Economics 1997) index to determine their firm-level investment sensitivity to capital flow shocks and whether future firm-level asset growth is linked to country-level flow-implied fund allocation (FIFA).

The target audience for this research is broad because macroeconomic cross-border capital flows affect practitioners in corporate finance, foreign retail investors (mutual funds), and academics. The concepts relating to financial asset fire sales, or “forced trading,” are also useful for understanding asset market liquidity and the valuation of financial assets.

For the country-level analysis, each of the 25 countries is studied in terms of FIFA and representative stock index returns. FIFA is described as the amount of capital that a particular emerging market can expect to see enter or exit because of subscriptions or redemptions faced by invested funds. The authors find high correlations between FIFA and equity market returns for global mutual funds in China and India. This finding implies that forced trading leads to significant price effects in local markets as well as the real economy. Furthermore, the authors conclude from the research that FIFA is a statistically significant factor for measuring exogenous capital flow shocks within the real economy.

The authors use a firm-level analysis based on firms in China and India; they obtain data from Compustat Global and note that firms’ aggregate investments are affected by these capital flow shocks (forced trading). Their research identifies a firm-level investment sensitivity to forced trading only for Chinese firms in industries that are more “equity dependent” because the cash flows are often more leveraged. In addition, the future asset growth in these firms is directly linked to country-level FIFA. The results for the firms within India are not deemed statistically significant enough to draw the same conclusion. An important concept to take away is that forced trading, which is a component of cross-border financial flows, affects not only market liquidity and investment prices but also the real economy.

The sample data are obtained from EPFR (global mutual fund data), Standard & Poor’s Emerging Market Database (country equity index return and market capitalization date), the respective national accounts through Datastream (gross fixed capital formation and gross domestic product), and Compustat North America and Global (firm-level accounting data). The sample period for the EPFR data is March 1996–June 2009 for 25 emerging markets. Most of the emphasis is on China and India because of their significant amount of global mutual fund investment and large volume of global cash flows and because they contain a wide cross section of firms with varying external finance needs, thereby allowing the authors to research the factors that cause capital flow market shocks.

Four main types of funds are covered: funds in the A-share market (qualified investors), funds in the B-share market, Hong Kong’s H-share market funds, and some American depositary receipts listed in New York. These funds are used because they are significant in influencing the environment of liquidity in these markets.

The authors use a country-level analysis for 25 emerging markets to understand the relationship between global fund capital flows and the macro economy where the funds are invested. They also use the Kaplan and Zingales index for a firm-level analysis only of firms within China and India. These data are from Compustat Global for the annual analysis period of 2003–2009 for China and 2001–2009 for India. The authors are successful in meeting their research objectives, but there are a number of limitations in the firm-level analysis of China and India.

Before providing the main concepts, evidence, and finally, the conclusions, the authors present a sufficient amount of background information. But the firm-level analysis is limited because of poor-quality accounting data, lack of more frequent balance sheet information, and the fact that firms in China and India may not be comparable because of differing firm maturation stages, labor, and capital decisions. Furthermore, the firm-level analysis of firms may have statistical measurement errors. One of the main independent variables, FIFA, may not accurately measure capital reallocations because it is serially correlated and its movement can be substantial across countries and time.