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

The paper uses a Panel Vector Auto-Regression (PVAR) approach to analyze the shortrun adjustment of private investment to shocks to fundamental and financial factors in emerging market economies. By relying on a panel of 31 emerging economies and quarterly frequency data for the period 1990:1-2008:3, we show that: (i) investment sluggishly adjusts to its own shocks; (ii) GDP and equity price shocks have a positive and sizeable impact on investment; (iii) unexpected variation in the cost of capital and the lending rate has a negative (although economically small) effect on investment; and (iv) the response of investment to credit market developments seems to be driven by the demand side. In addition, the empirical evidence suggests that the effects of equity price shocks are similar for emerging Asia and Latin America, but credit shocks are more important in Latin America. Moreover, shocks to the lending rate have a very pronounced and negative impact in emerging European markets. Finally, we show that the stock market bubbles may have encouraged real investment during the nineties.