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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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Related research

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. Rose, Andrew K & Engel, Charles, 2002. "Currency Unions and International Integration," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(4), pages 1067-89, November.
  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. Rose, Andrew K, 2003. "A Meta-Analysis of the Effect of Common Currencies on International Trade," CEPR Discussion Papers 4341, C.E.P.R. Discussion Papers.
  5. 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.
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Cited by:
  1. Matthias Busse & Carsten Hefeker & Signe Nelgen, 2013. "Foreign Direct Investment and Exchange Rate Regimes," Economics Bulletin, AccessEcon, vol. 33(1), pages 843-858.
  2. Sanja Samirana Pattnayak & Shandre M. Thangavelu, 2011. "Linkages and technology spillovers in the presence of foreign firms: Evidence from the Indian pharmaceutical industry," Journal of Economic Studies, Emerald Group Publishing, vol. 38(3), pages 275-286, July.
  3. Andrew J. Abbott & Glauco De Vita, 2011. "Evidence on the impact of exchange rate regimes on bilateral FDI flows," Journal of Economic Studies, Emerald Group Publishing, vol. 38(3), pages 253-274, July.
  4. Redoano, Michela, 2012. "Fiscal Interactions Among European Countries: Does the EU Matter?," CAGE Online Working Paper Series 101, Competitive Advantage in the Global Economy (CAGE).

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