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Liquidity, Institutional Quality and the Composition of International Equity Outflows

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Author Info
Itay Goldstein
Assaf Razin
Hui Tong

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Abstract

We examine the choice between Foreign Direct Investment and Foreign Portfolio Investment at the level of the source country. Based on a theoretical model, we predict that (1) source countries with higher probability of aggregate liquidity crises export relatively more FPI than FDI, and (2) this effect strengthens as the source country’s capital market transparency worsens. To test these hypotheses, we apply a dynamic panel model and examine the variation of FPI relative to FDI for 140 source countries from 1985 to 2004. Our key variable is the probability of an aggregate liquidity crisis, estimated from a Probit model, as proxied by episodes of economy-wide sales of external assets. Consistent with our theory, we find that the probability of a liquidity crisis has a strong effect on the composition of foreign equity investment. Furthermore, greater capital market opacity in the source country strengthens the effect of the crisis probability.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13723.

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Date of creation: Jan 2008
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Handle: RePEc:nbr:nberwo:13723

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Find related papers by JEL classification:
F2 - International Economics - - International Factor Movements and International Business
F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
F3 - International Economics - - International Finance
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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