The Value of Clean Hands: Public Policy and International Asset Allocation

Despite of the intuitive idea that corporate governance and transparency are crucial for a country's international appeal, foreign portfolio investors appear to care first and foremost about transparency, predictability and honesty in governments. This is, at least, what our analysis of international portfolio holdings implies. Our estimates further indicate that (i) a feasible improvement of government corruption and especially institutional quality can trigger an economically substantial rise in foreign interest for the stocks of that country; and (ii) an amelioration in country-level governance variables creates significantly higher effects on foreign equity demand than an improvement in traditional macroeconomic policy indicators.