Pessimistic foreign investors and turmoil in emerging markets : the case of Brazil in 2002

Abstract

Using survey data, we document that foreign-owned institutions became more pessimistic than locally owned institutions about the strength of the Brazilian currency around the 2002 presidential elections. As a result of their relative pessimism, foreignowned institutions made larger forecast errors. Consistent with the emergence of their relative pessimism, foreign investors heavily sold Brazilian stocks and the Brazilian currency in futures markets ahead of the 2002 elections. Periods of stronger foreign sell-off were associated with larger equity price declines and larger depreciation of the Brazilian Real in spot and futures markets. These results are consistent with foreign investors’ lack of knowledge of Brazilian institutions contributing to the sharp depreciation of the Brazilian currency and stock market ahead of the 2002 presidential elections