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Common Currencies and FDI Flows

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  • Stefano Schiavo

Abstract

The paper investigates the impact of EMU on foreign direct investment flows. Using the option value approach to investment decisions, it is possible to show how exchange rate uncertainty hinders cross-border investment flows. By permanassume trading to take place in discrete time inside an endogenous price formation setting. Traders demand for the risky asset is expressed as a fraction of their individual wealth and is based on future prices forecast obtained on the basis of past market history. The general case is studied in which an arbitrary large number of heterogeneous traders operates in the market and any smooth function which maps the infinite information set to the present investment choice is allowed as agent's trading behavior. A complete characterization of equilibria is given and their stability conditions are derived. We find that this economy can only possess isolated generic equilibria where a single agent dominates the market and continuous manifolds of non-generic equilibria where many agents hold finite wealth shares. We show that irrespectively of agents number and of their behavior, all possible equilibria belong to a one dimensional "Equilibria Market Line". Finally we discuss the relative performances of different strategies and the selection principle governing market dynamics.

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Bibliographic Info

Paper provided by Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy in its series LEM Papers Series with number 2005/07.

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Date of creation: 30 Apr 2005
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Handle: RePEc:ssa:lemwps:2005/07

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Keywords: EMU; Currency Union; FDI; Uncertainty; Investment.;

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References

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  1. Richard Portes & Helene Rey, 1999. "The Determinants of Cross-Border Equity Flows," NBER Working Papers 7336, National Bureau of Economic Research, Inc.
  2. Portes, Richard & Rey, Helene & Oh, Yonghyup, 2001. "Information and capital flows: The determinants of transactions in financial assets," European Economic Review, Elsevier, vol. 45(4-6), pages 783-796, May.
  3. Andrew K. Rose, 2000. "One money, one market: the effect of common currencies on trade," Economic Policy, CEPR;CES;MSH, vol. 15(30), pages 7-46, 04.
  4. Engel, Charles M & Rose, Andrew K, 2001. "Currency Unions and International Integration," CEPR Discussion Papers 2659, C.E.P.R. Discussion Papers.
  5. Andrew Rose, 2004. "A Meta-Analysis of the Effect of Common Currencies on International Trade," NBER Working Papers 10373, National Bureau of Economic Research, Inc.
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Cited by:
  1. Matthias Busse & Carsten Hefeker & Signe Nelgen, 2010. "Foreign Direct Investment and Exchange Rate Regimes," MAGKS Papers on Economics 201015, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
  2. Anokye M. Adam, 2013. "Currency Union and Foreign Direct Investment Inflow: Evidence from Economic Community of West African States (ECOWAS)," SPOUDAI Journal of Economics and Business, SPOUDAI Journal of Economics and Business, University of Piraeus, vol. 63(1-2), pages 121-132, June.
  3. Nicolas Coeurdacier & Roberto A. de Santis & Antonin Aviat, 2009. "Cross-border mergers and acquisitions and European integration," Sciences Po publications info:hdl:2441/c8dmi8nm4pd, Sciences Po.
  4. Anokye M. Adam, 2013. "Currency Union And Foreign Direct Investment Inflow: Evidence From Economic Community Of West African States (Ecowas)," Far East Journal of Psychology and Business, Far East Research Centre, vol. 11(5), pages 73-81, May.
  5. Estrella Gómez Herrera, 2010. "Comparing alternative methods to estimate gravity models of bilateral trade," ThE Papers 10/05, Department of Economic Theory and Economic History of the University of Granada..
  6. Cuneyt KILIC & Yýlmaz BAYAR & Feyza ARICA, 2014. "Effects of Currency Unions on Foreign Direct Investment Inflows: The European Economic and Monetary Union Case," International Journal of Economics and Financial Issues, Econjournals, vol. 4(1), pages 8-15.
  7. Coeurdacier, Nicolas & De Santis, Roberto A. & Aviat, Antonin, 2009. "Cross-Border Mergers and acquisitions: Financial and institutional forces," Working Paper Series 1018, European Central Bank.
  8. repec:spo:wpecon:info:hdl:2441/c8dmi8nm4pdjkuc9g70aj72cl is not listed on IDEAS

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