Financial Globalization & Democracy: Foreign Capital, Domestic Capital, and Political Uncertainty in the Emerging Worl

Existing approaches to financial globalization have often assumed that global capital markets are a monolithic entity consisting of homogeneous investors with the same interests and information. This project challenges this assumption by disaggregating the market responses of international and local portfolio investors to political events in emerging markets. I argue that, despite the increasing globalization of capital, domestic financial investors remain key in financial market-government relations. First, local investors lead the way in market responses to political events. Less well-informed foreign investors take cues from better-informed domestic investors, following the lead of locals who are "on the ground." Second, domestic investors respond more vigorously to political events, as insufficient international risk sharing makes them especially sensitive to local political risk. These two factors put local investors at the forefront of capital market responses to political events. I test this argument empirically using pricing data for closed-end country funds and capital flow data for onshore and offshore investment funds -- which afford a unique opportunity to examine interactions between international and local investors. Multivariate time series analyses of financial contagion and event study estimates of the impact of national elections on financial markets find that local investors are particularly sensitive to political uncertainty and that political shocks propagate from local to international markets. The findings demonstrate that a model that places local investors front and center improves our understanding of financial market discipline in the emerging world.