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The Effect of Capital Controlson Foreign Direct Investment Decisions Under Country Risk with Intangible Assets

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  • Kinga Z. Elo
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    Abstract

    This paper examines how capital controls affect FDI decisions and how the impact of these restrictive measures varies with different levels of country risk. We construct a model of firms'' FDI decisions, broadly in Dunning''s "eclectic theory" framework, using "real options" to emphasize economic uncertainty and country risk. Numerical results of the model take the form of "quality statistics" that uncover the underlying dynamics hidden in the aggregate data that is responsible for the low performance of recent empirical studies. We find that increasing levels of capital controls reduce the life-span of FDI investments at each level of country risk and foreign investors'' willingness towards risk sharing increases. We reveal a significant interaction between capital control and country risk, resulting in a nonlinear relationship between these and the volatility and volume statistics. We estimate a standard cross-sectional model that provides strong support for our theoretical findings.

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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 07/79.

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    Length: 62
    Date of creation: 01 Apr 2007
    Date of revision:
    Handle: RePEc:imf:imfwpa:07/79

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    Keywords: Capital controls; Foreign investment; Credit risk; fdi; capital control; direct investment; foreign direct investment; foreign investors; capital movements; direct investments; capital flows; foreign direct investments; investment decisions; foreign investor; host economy; foreign capital; capital market; foreign operation; foreign direct investors; capital inflows; foreign investments; capital account liberalization; capital markets; foreign ownership; short-term capital; capital restrictions; international capital; investment decision; host country; foreign market; measures of volatility; capital outflow; inward foreign direct investment; investment climate; volatility of capital flows; capital inflow; capital market liberalization; capital formation; government bonds; equity investments; equity risk premium; portfolio investment; capital outflows; capital owners; international capital flows; capital stock; foreign knowledge; international investment; cost of capital; host economies; access to capital markets; foreign capital inflows; aggregate capital flows; foreign asset; debt service; industry demand; option pricing; foreign securities; stock market; capital account restrictions; put options; capital account crises; multinational enterprises; foreign direct investor; capital flow volatilities; gross capital formation; capital market equilibrium; capital flow; private foreign investments; foreign counterpart; fdis; international capital market; direct investment statistics;

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    13. Eswar Prasad & Qing Wang & Thomas Rumbaugh, 2005. "Putting the Cart Before the Horse? Capital Account Liberalization and Exchange Rate Flexibility in China," IMF Policy Discussion Papers 05/1, International Monetary Fund.
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