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A Mean-Variance Explanation of FDI Flows to Developing Countries

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  • Eva Rytter Sunesen

    (Department of Economics, University of Copenhagen)

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    Abstract

    An important feature of the world economy is the close global and regional integration due to strong trade and investment relations among countries. The high degree of integration between countries is likely to give rise to business cycle synchronisation in which case shocks will spillover from one country to another. This will have implications for the way investors evaluate the return and risk of investing abroad. This paper utilises a simple mean-variance optimisation framework where global and regonal factors capture the interdependence between countries. The model implies that FDI is driven by the risk-adjusted rate of return as well as global and regional spillovers. The preditions of the model are con rmed in a sample of 60 countries over the period 1970-2000.

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    File URL: http://www.econ.ku.dk/english/research/publications/wp/2008/0817.pdf
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    Bibliographic Info

    Paper provided by University of Copenhagen. Department of Economics in its series Discussion Papers with number 08-17.

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    Length: 17 pages
    Date of creation: Aug 2008
    Date of revision:
    Handle: RePEc:kud:kuiedp:0817

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    Keywords: foreign direct investment; risk; portfolio; business cycles;

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    1. Frankel, Jeffrey A & Rose, Andrew K, 1998. "The Endogeneity of the Optimum Currency Area Criteria," Economic Journal, Royal Economic Society, vol. 108(449), pages 1009-25, July.
    2. Marianne Baxter & Michael Kouparitsas, 2004. "Determinants of business cycle comovement: a robust analysis," Working Paper Series WP-04-14, Federal Reserve Bank of Chicago.
    3. Kalman J. Cohen & Jerry A. Pogue, 1967. "An Empirical Evaluation of Alternative Portfolio-Selection Models," The Journal of Business, University of Chicago Press, vol. 40, pages 166.
    4. Fearon, James D, 2003. " Ethnic and Cultural Diversity by Country," Journal of Economic Growth, Springer, vol. 8(2), pages 195-222, June.
    5. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
    6. Heathcote, Jonathan & Perri, Fabrizio, 2004. "Financial globalization and real regionalization," Journal of Economic Theory, Elsevier, vol. 119(1), pages 207-243, November.
    7. Pagan, Adrian, 1984. "Econometric Issues in the Analysis of Regressions with Generated Regressors," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 25(1), pages 221-47, February.
    8. Eva Rytter Sunesen, 2006. "Measuring Idiosyncratic Risk: Implications for Capital Flows," Discussion Papers 06-20, University of Copenhagen. Department of Economics.
    9. M. Ayhan Kose & Christopher Otrok & Charles H. Whiteman, 2003. "International Business Cycles: World, Region, and Country-Specific Factors," American Economic Review, American Economic Association, vol. 93(4), pages 1216-1239, September.
    10. Rajan, Murli & Friedman, Joseph, 1997. "An examination of the impact of country risk on the international portfolio selection decision," Global Finance Journal, Elsevier, vol. 8(1), pages 55-70.
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