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An Information-Based Trade-off Between Foreign Direct Investment and Foreign Portfolio Investment: Volatility, Transparency and

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  • Razin, Assaf
  • Goldstein, Itay

Abstract

The Paper develops a model of foreign direct investments (FDI) and foreign portfolio investments. FDI is characterized by hands-on management style that enables the owner to obtain relatively refined information about the productivity of the firm. This superiority, relative to portfolio investments, comes with a cost: a firm owned by the relatively well-informed FDI investor has a low resale price because of ?lemons? type asymmetric information between the owner and potential buyers. Consequently, investors who have a higher (lower) probability of getting a liquidity shock that forces them to sell early will invest in portfolio (direct) investments. This result can explain the greater volatility of portfolio investments relative to direct investments. Motivated by empirical evidence, we show that this pattern may be weaker in developed economies that have higher levels of transparency in the capital market and better corporate governance. We also study welfare implications of the model.

Suggested Citation

  • Razin, Assaf & Goldstein, Itay, 2003. "An Information-Based Trade-off Between Foreign Direct Investment and Foreign Portfolio Investment: Volatility, Transparency and," CEPR Discussion Papers 3747, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:3747
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    References listed on IDEAS

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    Cited by:

    1. Straub, Stephane, 2008. "Opportunism, corruption and the multinational firm's mode of entry," Journal of International Economics, Elsevier, vol. 74(2), pages 245-263, March.
    2. Martin Bohl & Frank McDonald & Heinz-Josef Tuselmann & Svitlana Voronkova & Paul Windrum, 2011. "The German model of capitalism and the persistence of outward foreign direct investment: evidence from German manufacturing industries," Economy of region, Centre for Economic Security, Institute of Economics of Ural Branch of Russian Academy of Sciences, vol. 1(2), pages 119-125.
    3. Yamin Ahmad & Pietro Cova & Rodrigo Harrison, 2004. "Foreign Direct Investment versus Portfolio Investment : A Global Games Approach," Working Papers 05-03, UW-Whitewater, Department of Economics.

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    JEL classification:

    • F00 - International Economics - - General - - - General
    • F20 - International Economics - - International Factor Movements and International Business - - - General
    • F30 - International Economics - - International Finance - - - General

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