Liquidity, Institutional Quality and the Composition of International Equity Flows
AbstractFDI investors control the management of the firms, whereas FPI investors delegate decisions to managers. Therefore, direct investors are more informed than portfolio investors about the prospects of projects. This information enables them to manage their projects more efficiently. However, if investors need to sell their investments before maturity because of liquidity shocks, the liquidation price they can get will be lower when buyers know that they have more information on investment projects. In this paper we examine the choice between Foreign Direct Investment and Foreign Portfolio Investment at the level of the source country. Based on the Goldstein and Razin model, we predict that (1) source countries with higher expectation of future liquidity problems 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 examine the variation of FPI relative to FDI for source countries from 1985 to 2004. Our key variable is the predicted severity of liquidity shock, as proxied by episodes of economy-wide sales of external assets. Consistent with our theory, we find that the predicted liquidity shock 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 liquidity shock.
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Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15727.
Date of creation: Feb 2010
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Find related papers by JEL classification:
- F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
- F3 - International Economics - - International Finance
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-02-20 (All new papers)
- NEP-IFN-2010-02-20 (International Finance)
- NEP-PPM-2010-02-20 (Project, Program & Portfolio Management)
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- Assaf Razin & Anuk Serechetapongse, 2010.
"Equity Prices and Equity Flows: Testing Theory of the Information-Efficiency Tradeoff,"
NBER Working Papers
16651, National Bureau of Economic Research, Inc.
- Assaf Razin & Anuk Serechetapongse, 2011. "Equity Prices and Equity Flows: Testing Theory of the Information-Efficiency Tradeoff," Working Papers 292011, Hong Kong Institute for Monetary Research.
- Xingwang Qian & Andreas Steiner, 2012. "International Reserves and the Composition of Equity Capital Inflows," Working Papers 90, Institute of Empirical Economic Research.
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