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The Endogeneity of the Exchange Rate as a Determinant of FDI: A Model of Money, Entry, and Multinational Firms

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  • Russ, Katheryn

Abstract

This paper argues that when the exchange rate and projected sales in the host country are jointly determined by underlying macroeconomic variables, standard regressions of FDI flows on both exchange rate levels and volatility are subject to bias. The results hinge on the interaction of macroeconomic uncertainty, a sunk cost, and heterogeneous productivity across firms. They indicate that a multinational firm’s response to increases in exchange rate volatility will differ depending on whether the volatility arises from shocks in the firm’s native or host country. It is the first study to depart from the representative-firm framework in an analysis of direct investment behavior with money.

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Bibliographic Info

Paper provided by Department of Economics, UC Santa Cruz in its series Santa Cruz Department of Economics, Working Paper Series with number qt9xr4f238.

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Date of creation: 01 Sep 2004
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Handle: RePEc:cdl:ucscec:qt9xr4f238

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  1. Caglayan, M. & Baum, C.F. & Barkoulas, J.T., 1998. "Exchange Rate Effects on the Volume and Variability of Trade Flows," Papers 1998/05, Koc University.
  2. Obstfeld, M., 1998. "Risk and Exchange Rate," Papers 193, Princeton, Woodrow Wilson School - Public and International Affairs.
  3. Silvana Tenreyro, 2003. "On the trade impact of nominal exchange rate volatility," Working Papers 03-2, Federal Reserve Bank of Boston.
  4. Deaton, Angus, 1992. "Understanding Consumption," OUP Catalogue, Oxford University Press, number 9780198288244.
  5. Ghironi, Fabio & Melitz, Marc J, 2004. "International Trade and Macroeconomic Dynamics with Heteroegenous Firms," CEPR Discussion Papers 4595, C.E.P.R. Discussion Papers.
  6. Dunning, John H, 1973. "The Determinants of International Production," Oxford Economic Papers, Oxford University Press, vol. 25(3), pages 289-336, November.
  7. Mark J. Melitz, 2002. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," NBER Working Papers 8881, National Bureau of Economic Research, Inc.
  8. Horstmann, Ignatius J. & Markusen, James R., 1992. "Endogenous market structures in international trade (natura facit saltum)," Journal of International Economics, Elsevier, vol. 32(1-2), pages 109-129, February.
  9. Agathe Cote, . "Exchange Rate Volatility and Trade: A Survey," Working Papers 94-5, Bank of Canada.
  10. Chari, V V & Kehoe, Patrick J & McGrattan, Ellen R, 2002. "Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?," Review of Economic Studies, Wiley Blackwell, vol. 69(3), pages 533-63, July.
  11. Tamim Bayoumi, 1994. "A Formal Model of Optimum Currency Areas," IMF Working Papers 94/42, International Monetary Fund.
  12. Campa, Joe Manuel, 1993. "Entry by Foreign Firms in the United States under Exchange Rate Uncertainty," The Review of Economics and Statistics, MIT Press, vol. 75(4), pages 614-22, November.
  13. Froot, Kenneth A & Stein, Jeremy C, 1991. "Exchange Rates and Foreign Direct Investment: An Imperfect Capital Markets Approach," The Quarterly Journal of Economics, MIT Press, vol. 106(4), pages 1191-217, November.
  14. Khalid Sekkat & Olivia Galgau, 2004. "The impact of the single market and the single currency on foreign direct investment in the European Union," ULB Institutional Repository 2013/7396, ULB -- Universite Libre de Bruxelles.
  15. Pietra Rivoli & Eugene Salorio, 1996. "Foreign Direct Investment and Investment under Uncertainty," Journal of International Business Studies, Palgrave Macmillan, vol. 27(2), pages 335-357, June.
  16. Robert E. Lipsey, 1998. "Internationalized Production in Developed and Developing Countries and in Industry Sectors," NBER Working Papers 6405, National Bureau of Economic Research, Inc.
  17. Sung, Hongmo & Lapan, Harvey E, 2000. "Strategic Foreign Direct Investment and Exchange-Rate Uncertainty," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 41(2), pages 411-23, May.
  18. Takao Itagaki, 1981. "The Theory of the Multinational Firm under Exchange Rate Uncertainty," Canadian Journal of Economics, Canadian Economics Association, vol. 14(2), pages 276-97, May.
  19. Jane Ihrig, 2001. "Exchange-rate exposure of multinationals: focusing on exchange-rate issues," International Finance Discussion Papers 709, Board of Governors of the Federal Reserve System (U.S.).
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Cited by:
  1. Buch, Claudia M. & Kesternich, Iris & Lipponer, Alexander & Schnitzer, Monika, 2009. "Financial constraints and the margins of FDI," Discussion Paper Series 1: Economic Studies 2009,29, Deutsche Bundesbank, Research Centre.
  2. Lilia Cavallari, 2012. "Modelling Entry Costs: Does It Matter For Business Cycle Transmission?," Working Papers 0712, CREI Università degli Studi Roma Tre, revised 2012.
  3. Dorn, Sabrina & Egger, Peter, 2012. "On the Distribution of Exchange Rate Regime Treatment Effects on International Trade," Annual Conference 2012 (Goettingen): New Approaches and Challenges for the Labor Market of the 21st Century 62054, Verein für Socialpolitik / German Economic Association.
  4. Cavallari Lilia, 2011. "Firms entry, monetary policy and the international business cycle," wp.comunite 0086, Department of Communication, University of Teramo.
  5. Fabio Ghironi & Marc Melitz, 2004. "International Trade and Macroeconomic Dynamics with Heterogeneous Firms," 2004 Meeting Papers 451, Society for Economic Dynamics.
  6. Buch, Claudia M. & Lipponer, Alexander, 2005. "Business cycles and FDI: evidence from German sectoral data," Discussion Paper Series 1: Economic Studies 2005,09, Deutsche Bundesbank, Research Centre.

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