Systemic Liquidity And The Composition Of Foreign Investment: Theory And Empirical Evidence

Topics:
Foreign Direct Investment
Tags:
Finance,
Investment,
Liquidity,
Theory
Source:
University of Pennsylvania

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Overview: This paper studies the impact of liquidity on investors' choice between FDI and FPI. As argued in Goldstein and Razin (2006), this choice could be influenced by the trade off between management efficiency and liquidity effects. Here we extend their model by assuming liquidity shocks to individual investors are triggered by aggregate liquidity shocks. A key prediction then is that countries with higher probability of aggregate liquidity crises will be the source of more FPI and less FDI. Our key variable is the probability, estimated from Probit models, of liquidity shocks, as proxied by real interest rate hike or real exchange rate depreciation. It turns out that liquidity shocks have strong effects on the composition of foreign investment, as predicted by our model.

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Format: PDF | Size: 385KB | Date: Dec 2006 | Pages: 26

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