ABSTRACT
This chapter analyses the determinants of the balance of payments by discussing the nature, causes, and measurement of international capital flows. It provides a very general and comparatively lengthy theoretical description of international capital flows of all varieties, followed by presentation of a framework for analyzing particular capital flows. The chapter discusses the empirical application of the theoretical model, and deals with the concrete choice of explanatory variables. The theory of international capital movements is in considerable turmoil. Traditionally, models of international capital transactions have been based upon a set of independent activities, typically trade, interest arbitrage, and forward market speculation. The chapter also discusses the selection of the variables that appropriately reflect the risks and returns of specific types of investments and their close substitutes. It describes speculation as the acquisition of forward contracts to buy foreign exchange in anticipation that the spot rate will be higher than the forward rate.
