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Multinational Firms, Monopolistic Competition and Foreign Investment Uncertainty

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Author Info
Arunish Chawla
Abstract

This is a model of multinational firms, which introduces option value of foreign directinvestment, into a framework of Dixit-Stiglitz type monopolistic competition. Starting from apure trading equilibrium and solving for the optimal investment rule gives a scale-up factorwhich implies existence of a wedge between markup revenues and foreign investment costs.Greater volatility and risk aversion increase this scale-up over foreign investment costsimplying a delay in the exercise of FDI option, while growing market size and nationalincome facilitate early exercise. The model is extended to include a Poisson jump process,which has policy implications for FDI reforms and explains 'wait and watch' behaviour ofmultinational firms better than a pure comparative advantage-trade cost framework does.While investment under uncertainty literature is based on the theory of call options, I solve'FDI option' as a put option, thereby also enriching the theory of real options.

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Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp0866.

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Date of creation: Apr 2008
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Related research
Keywords: Multinational firm; monopolistic competition; foreign investment uncertainty; FDI option;

Find related papers by JEL classification:
F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business

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  1. S. Lael Brainard, 1993. "A Simple Theory of Multinational Corporations and Trade with a Trade-Off Between Proximity and Concentration," NBER Working Papers 4269, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. James E. Anderson & Eric van Wincoop, 2004. "Trade Costs," NBER Working Papers 10480, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  4. Bruce A. Blonigen, 2005. "A Review of the Empirical Literature on FDI Determinants," NBER Working Papers 11299, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  5. Richard Baldwin, 1988. "Hysteresis In Import Prices: The Beachhead Effect," NBER Working Papers 2545, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  6. Elhanan Helpman & Marc J. Melitz & Stephen R. Yeaple, 2003. "Export versus FDI," Harvard Institute of Economic Research Working Papers 1998, Harvard - Institute of Economic Research. [Downloadable!]
    Other versions:
  7. Bruce Blonigen, 2005. "A Review of the Empirical Literature on FDI Determinants," Atlantic Economic Journal, International Atlantic Economic Society, vol. 33(4), pages 383-403, December. [Downloadable!] (restricted)
  8. Rafael Rob & Nikolaos Vettas, 2003. "Foreign Direct Investment and Exports with Growing Demand," PIER Working Paper Archive 03-001, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania. [Downloadable!]
  9. Robert C. Merton, 1973. "Theory of Rational Option Pricing," Bell Journal of Economics, The RAND Corporation, vol. 4(1), pages 141-183, Spring. [Downloadable!] (restricted)
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  11. Dixit, Avinash K. & Pindyck, Robert S. & Sødal, Sigbjørn., 1997. "A markup interpretation of optimal rules for irreversible investment," Working papers WP 3945-97., Massachusetts Institute of Technology (MIT), Sloan School of Management. [Downloadable!]
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  12. Magnus Blomstrom & Irving B. Kravis & Robert E. Lipsey, 1988. "Multinational Firms and Manufactured Exports from Developing Countries," NBER Working Papers 2493, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  13. McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 707-27, November. [Downloadable!] (restricted)
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  15. Guay, Wayne & Kothari, S. P, 2003. "How much do firms hedge with derivatives?," Journal of Financial Economics, Elsevier, vol. 70(3), pages 423-461, December. [Downloadable!] (restricted)
  16. Markusen, James R. & Venables, Anthony J., 1998. "Multinational firms and the new trade theory," Journal of International Economics, Elsevier, vol. 46(2), pages 183-203, December. [Downloadable!] (restricted)
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  17. Lipsey, Robert E & Weiss, Merle Yahr, 1981. "Foreign Production and Exports in Manufacturing Industries," The Review of Economics and Statistics, MIT Press, vol. 63(4), pages 488-94, November. [Downloadable!] (restricted)
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