Common Currencies and FDI Flows
AbstractThe 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 InfoPaper 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.
Date of creation: 30 Apr 2005
Date of revision:
EMU; Currency Union; FDI; Uncertainty; Investment.;
Other versions of this item:
- NEP-ALL-2005-05-14 (All new papers)
- NEP-EEC-2005-05-14 (European Economics)
- NEP-IFN-2005-05-14 (International Finance)
- NEP-MON-2005-05-14 (Monetary Economics)
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