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The Stock Market and Investment: Evidence from FDI Flows

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  • Malcolm Baker
  • C. Fritz Foley
  • Jeffrey Wurgler

Abstract

Foreign direct investment offers a rich laboratory in which to study the broader economic effects of securities market mispricing. We outline and test two mispricing-based theories of FDI. The cheap assets' or fire-sale theory views FDI inflows as the purchase of undervalued host country assets, while the cheap capital' theory views FDI outflows as a natural use of the relatively lowcost capital available to overvalued firms in the source country. The empirical results support the cheap capital view: FDI flows are unrelated to host country stock market valuations, as measured by the aggregate market-to-book-value ratio, but are strongly positively related to source country valuations and negatively related to future source country stock returns. The latter effects are most pronounced in the presence of capital account restrictions, suggesting that such restrictions limit cross-country arbitrage and thereby increase the potential for mispricing-driven FDI.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10559.

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Date of creation: Jun 2004
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Handle: RePEc:nbr:nberwo:10559

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Cited by:
  1. Joanna Tyrowicz, 2009. "Blame No One? Investment Decisions Of The Polish Stock-listed Companies," Working Papers 2009-06, Faculty of Economic Sciences, University of Warsaw.
  2. Malcolm Baker & Richard S. Ruback & Jeffrey Wurgler, 2004. "Behavioral Corporate Finance: A Survey," NBER Working Papers 10863, National Bureau of Economic Research, Inc.
  3. Kristin J. Forbes, 2007. "The Microeconomic Evidence on Capital Controls: No Free Lunch," NBER Chapters, in: Capital Controls and Capital Flows in Emerging Economies: Policies, Practices and Consequences, pages 171-202 National Bureau of Economic Research, Inc.
  4. Geert Bekaert & Campbell R. Harvey & Christian Lundblad & Stephan Siegel, 2007. "Global Growth Opportunities and Market Integration," Journal of Finance, American Finance Association, American Finance Association, vol. 62(3), pages 1081-1137, 06.
  5. Chiara Criscuolo & Ralf Martin, 2005. "Multinationals and US productivity leadership: evidence from Great Britain," LSE Research Online Documents on Economics, London School of Economics and Political Science, LSE Library 19914, London School of Economics and Political Science, LSE Library.
  6. Massa, Massimo & Peyer, Urs & Tong, Zhenxu, 2005. "Limits of Arbitrage and Corporate Financial Policy," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4829, C.E.P.R. Discussion Papers.
  7. Md. Al-Mamun, 2013. "The Effect of Macroeconomic & Market Specific Dynamics on Stock Market Development in Global Growth Generator Countries," Asian Economic and Financial Review, Asian Economic and Social Society, Asian Economic and Social Society, vol. 3(9), pages 1152-1169, September.
  8. Chiara Criscuolo & Ralf Martin, 2009. "Multinationals and U.S. Productivity Leadership: Evidence from Great Britain," The Review of Economics and Statistics, MIT Press, vol. 91(2), pages 263-281, May.
  9. Coeurdacier, Nicolas & De Santis, Roberto A. & Aviat, Antonin, 2009. "Cross-Border Mergers and acquisitions: Financial and institutional forces," Working Paper Series, European Central Bank 1018, European Central Bank.

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