We investigate the strategic incentives for vertical foreign investment by risk-neutral oligopolistic firms and the effect of exchange rate uncertainty. Firms competing in a domestic final good market meet their input requirements either by investing abroad and producing their input requirement through a foreign subsidiary or by importing at the market price in an oligopolistic intermediate good market abroad. Investing firms can bid up the input price faced by their rivals through strategic purchase. We show that an increase in foreign exchange variability has a positive effect on vertical foreign direct investment and on trade in the intermediate good. We demonstrate the possibility of multiple equilibria as well as complementarity and herding in investment decisions.
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Find related papers by JEL classification: D43 - Microeconomics - - Market Structure and Pricing - - - Oligopoly and Other Forms of Market Imperfection F2 - International Economics - - International Factor Movements and International Business F31 - International Economics - - International Finance - - - Foreign Exchange