This paper analyzes the dynamic impact of a joint liberalization of capital movements and of the domestic financial sector. Both a simultaneous and a sequential liberalization are examined in an overlapping-generations model with a q-theory of investment. A liberalization generally leads to an initial period of capital inflows followed by capital outflows. It also increases investment and causes an overshooting in share prices. Furthermore, the interest rate level before a liberalization will usually not indicate the direction of net capital flows. Copyright 1992 by The London School of Economics and Political Science.