Can Economic Troubles Be Better Predicted? A New Tool Says Yes.

In the fast-paced world of global finance, money is always on the move. At times, much of that movement is consistent and relatively predictable. Cash tends to migrate toward economies that promise higher growth and better returns. 

But over the past few decades, economists have grown accustomed to what’s known in the trade as “sudden stops”— abrupt halts in capital flows that trigger instability and financial crises.

That was the case during the Asian financial crisis of 1997-1998 and again in the global financial crisis (GFC) of 2008-2009. More recently, analysts have warned that “America First” policies could spark a similar disruption for emerging markets if capital is redirected toward the U.S.

What if we could predict stock and bond inflows more accurately? Or quickly determine whether a sharp drop in portfolio flows was temporary or the “new normal”? Economists at the University of Virginia’s Darden School of Business believe they can — thanks to a new tool: KF*.

The Big Idea

Francis E. Warnock, the James C. Wheat Jr. Professor of Business Administration at UVA Darden, says capital flows — specifically, gross portfolio flows, or inflows into a country’s stock and bond markets — fluctuate around a natural level.

Together with co-authors Veronica Cacdac Warnock, a professor of practice and Batten Institute Fellow at Darden, and John D. Burger of Loyola University Maryland, Warnock has developed KF* — a measure of the natural, or benchmark, level of capital flows.

It’s not just a theoretical model: the co-authors have taught several central banks and the World Bank to apply it to real-world scenarios. (See Professor Frank Warnock’s 2021 presentation to the Central Bank of Chile.) 

How KF* Works

KF* estimates how much foreign portfolio investment a country can expect over time, based on:

• Total world savings, or the global pool of new money available for investment each period. (“World” here is the rest of the world, or ROW. That is, the amount of savings generated by the world, excluding your country).
• A country’s share of global bond and stock portfolios (how big a slice of the global investment pie typically goes there).

The formula multiplies a country’s share of global investment flows by the current global savings pool — generating a benchmark that shifts in real time as global or local conditions change.

When global savings increase or a country becomes more attractive to investors, KF* rises. When those conditions reverse, KF* falls.

What KF* Tell Us

KF* serves as a “normal level” against which actual capital inflows can be measured. In practice, real-world capital flows fluctuate around this benchmark — sometimes running above it, sometimes below.

This variance from the benchmark provides valuable insights. When actual inflows significantly exceed KF*, it often signals an unsustainable boom — a situation where investment capital may abruptly reverse direction later. Conversely, when inflows fall below the KF* benchmark, it typically indicates that flows are likely to recover, gravitating back toward that normal level.

Before KF*, countries lacked a reliable way to assess whether their current capital inflows represented a new normal or a temporary aberration, making it harder for policymakers to respond appropriately.

Predicting Sudden Stops

KF* provides a valuable framework for forecasting capital movement trends, particularly in predicting the dreaded “sudden stops” that can destabilize economies. When a country experiences inflows significantly exceeding its KF* benchmark, warning lights should flash — this elevation indicates a heightened risk of a sudden stop, where foreign investment abruptly plummets, often coinciding with local stock market declines.

Conversely, nations with inflows running below their level face substantially lower risks of dramatic crashes, simply because there isn't a major overshoot requiring correction. This differential, or the “KF* gap” — the difference between actual inflows and KF* — offers a useful analytical tool for identifying vulnerable economies versus those positioned for potential rebounds.

KF* in Action: Lessons from the GFC and COVID-19

The 2008 Global Financial Crisis provides a compelling case study for KF*'s predictive power.

Before the crisis, the warning signs were clearly visible through the KF* lens: many countries had capital flows well above their KF* benchmarks. Once the crisis hit, those with the largest positive gaps — those furthest above their KF* levels — experienced the sharpest reversals.

The contrasting scenario played out during the 2020 pandemic shock. Then, most countries did not have excessive inflows relative to KF* — and the model accurately signaled that a wave of sudden stops was unlikely. Flows recovered relatively quickly after the initial disruption.

Implications for Policymakers, Investors and Researchers

For governments and central banks, KF* is a diagnostic tool, helping them determine whether current portfolio inflows are part of a sustainable trend or a short-term spike. That distinction affects whether long-term policy shifts are warranted.

For investors, KF* can flag when inflows into a market reflect strong fundamentals — or unsustainable bubbles.

For economists, KF* offers a useful framework for modeling global capital movements and improving forecasts of financial stability.

This article is based on the following papers co-authored by Darden professors Francis E. Warnock and Veronica Cacdac Warnock, along with John D. Burger of Loyola University Maryland’s Sellinger School of Business: “A Natural Level of Capital Flows” (2022), published in Journal of Monetary Economics; “KF* and Portfolio Flows around Global Shocks” (draft 2025); and “Benchmarking Portfolio Flows” (2018), published in IMF Economic Review.