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Foreign Direct Investment, Exchange Rate Variability and Demand Uncertainty

  • Goldberg, Linda S.
  • Kolstad, Charles D.

Variable real exchange rates influence the location of production facilities chosen by a multinational. With risk averse investors and fixed productive factors, parent companies should not be indifferent to production location, even with identical expected costs of production across countries. If a nonnegative correlation exists between export demand and exchange rate shocks, the multinational optimally locates some productive capacity abroad. The capacity share abroad increases as exchange rate volatility rises and becomes more correlated with export demand shocks. These results are confirmed using quarterly U.S. bilateral foreign direct investment flows with Canada, Japan, and the United Kingdom. Copyright 1995 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

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File URL: http://econ.as.nyu.edu/docs/IO/9387/RR94-23.pdf
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Paper provided by C.V. Starr Center for Applied Economics, New York University in its series Working Papers with number 94-23.

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Length: 28 pages
Date of creation: 1994
Date of revision:
Handle: RePEc:cvs:starer:94-23
Contact details of provider: Postal: C.V. Starr Center, Department of Economics, New York University, 19 W. 4th Street, 6th Floor, New York, NY 10012
Phone: (212) 998-8936
Fax: (212) 995-3932
Web page: http://econ.as.nyu.edu/object/econ.cvstarr.html
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  1. Michael W. Klein & Eric S. Rosengren, 1992. "The real exchange rate and foreign direct investment in the United States: relative wealth vs. relative wage effects," Working Papers 92-2, Federal Reserve Bank of Boston.
  2. Goldberg, L.S. & Campa, J., 1993. "Investment in Manufacturing, Exchange-Rate and External Exposure," Working Papers 93-18, C.V. Starr Center for Applied Economics, New York University.
  3. de Meza, David & van der Ploeg, Frederick, 1987. "Production Flexibility as a Motive for Multinationality," Journal of Industrial Economics, Wiley Blackwell, vol. 35(3), pages 343-51, March.
  4. Joel Slemrod, 1989. "Tax Effects on Foreign Direct Investment in the United States: Evidence from a Cross-Country Comparison," NBER Working Papers 3042, National Bureau of Economic Research, Inc.
  5. Pindyck, Robert S., 1986. "Irreversible investment, capacity choice, and the value of the firm," Working papers 1802-86., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  6. Ethier, Wilfred J, 1986. "The Multinational Firm," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 805-33, November.
  7. Rudiger Dornbusch, 1988. "Credibility, Debt and Unemployment: Ireland's Failed Stabilization," NBER Working Papers 2785, National Bureau of Economic Research, Inc.
  8. Baldwin, Richard & Krugman, Paul, 1989. "Persistent Trade Effects of Large Exchange Rate Shocks," The Quarterly Journal of Economics, MIT Press, vol. 104(4), pages 635-54, November.
  9. Mussa, Michael, 1982. "A Model of Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 90(1), pages 74-104, February.
  10. Robert E. Lipsey, 1993. "Foreign Direct Investment in the United States: Changes over Three Decades," NBER Chapters, in: Foreign Direct Investment, pages 113-172 National Bureau of Economic Research, Inc.
  11. Craine, Roger, 1989. "Risky business : The allocation of capital," Journal of Monetary Economics, Elsevier, vol. 23(2), pages 201-218, March.
  12. Cushman, David O, 1985. "Real Exchange Rate Risk, Expectations, and the Level of Direct Investment," The Review of Economics and Statistics, MIT Press, vol. 67(2), pages 297-308, May.
  13. Hartman, Richard, 1972. "The effects of price and cost uncertainty on investment," Journal of Economic Theory, Elsevier, vol. 5(2), pages 258-266, October.
  14. Dixit, Avinash K, 1989. "Entry and Exit Decisions under Uncertainty," Journal of Political Economy, University of Chicago Press, vol. 97(3), pages 620-38, June.
  15. Goldberg, Linda S, 1993. "Exchange Rates and Investment in United States Industry," The Review of Economics and Statistics, MIT Press, vol. 75(4), pages 575-88, November.
  16. Abel, Andrew B, 1983. "Optimal Investment under Uncertainty," American Economic Review, American Economic Association, vol. 73(1), pages 228-33, March.
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