_5_ of the early international portfolio models followed the lobin-Brainard model (e.g., Branson and Henderson, 1985) where assets are assumed to be imperfect substitutes and asset demand functions are estimated. But few recent papers follow this approach to modelling capital flows (e. g., McKibbin and Sachs (1991) assume assets are perfect substitutes). And recent empirical international finance papers deal with tests on asset-prices and do not concern themselves with the implications for equilibrium adjustments in stock positions, i.e., capital flows. Moreover, research in this area with a specific focus on capital flows to developing countries is limited.

Nonetheless, the literature allows us to identify some factors which are likely to play an important role in motivating capital flows, once the special situation of (indebted) developing countries (which are likely credit rationed) is taken into account. First, there are countryspecific factors reflecting the opportunities and risks of investing in the country. Rates of return on stock markets, credit ratings, and secondary market prices of sovereign debt are thus likely to play a role in influencing the flows. Most of these indicators had an upward trend over the study period for the developing countries in our samp;_. Rates of returns on stock (equity) markets in many developing countries increased sharply in the last few years: over 1988-92, the IFC dollar-based composite index rose 294.2 percent for Latin America and 49.5 percent for Asia, compared to 108.4 percent for the S&P 500. Care should of course be taken to distinguish the ex-ante rates of return (which can motivate capital flows) from the measured ex-post rates. The credit ratings of many major developing countries also improvwd. For our sample of 9 Latin American countries the credit rating rose from an average of 27 points out of 100 in 1988 to 31 in 1992. Secondary market prices were higher by approximately two-thirds over end- 1989 (using the weighted price for the group of severely indebted developing countries). Furthermore, there was a general trend towards a larger role of the private sector in these developing countries, along with liberalization of their economies, especially opening up of the capital account.<sup>4</sup> Second, global factors may also have played an important influence. US short-term interest rates fell dramatically, by about half since 1988. For example, the three-month treasury bill rate was 3.3 percent at the end of 1992, compared to 5.9 percent at the beginning of 1988. Likewise, LIBOR on six-month US dollar deposits was 7.4 percent at the beginning of 1988, and s!9od at 3.7 percent at the end of 1992. Over this per;nd, three-year US interest rates fell by 2.7 percentage points from 7.9 percent in the beginning of 1988. Other rates of return in the US, e.g., on real estate, have also been low in this period. Declining returns in the US markets may not only have made it more attractive for US investors to seek higher returns abroad, but may also have induced holders of flight capital to repatriate their funds. The slowdown in the US economy over the 1989-1992 period may have further cor 'ibuted to the outflow of capital from the US. Regulatory and other changes in industrial coui..ies (such as the introduction of 4For general surveys of the experiences and (macro-economic) issues involved with liberalization of the capital account, see Hanson (1992), Mathieson and Rojas-Suarez (1992), and Reisen and Fischer (1993).