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Exchange Rates and Foreign Direct Investment: An Imperfect Capital Markets Approach

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  • Kenneth A. Froot
  • Jeremy C. Stein

Abstract

We examine the connection between exchange rates and foreign direct investment that arises when globally integrated capital markets are subject to informational imperfections. These imperfections cause external financing to be more expensive than internal financing, so that changes in wealth translate into changes in the demand for direct investment. By systematically lowering the relative wealth of domestic agents, a depreciation of the domestic currency can lead to foreign acquisitions of certain domestic assets. we develop a simple model of this phenomenon and test for its relevance in determining international capital flows.

Suggested Citation

  • Kenneth A. Froot & Jeremy C. Stein, 1989. "Exchange Rates and Foreign Direct Investment: An Imperfect Capital Markets Approach," NBER Working Papers 2914, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:2914 Note: ME ITI IFM
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    Cited by:

    1. Jonathan David Ostry & Anne Marie Gulde & Atish R. Ghosh & Holger C. Wolf, 1995. "Does the Nominal Exchange Rate Regime Matter?," IMF Working Papers 95/121, International Monetary Fund.
    2. Harry Grubert & John Mutti, 1991. "Financial Flows versus Capital Spending: Alternative Measures of U.S.-Canadian Investment and Trade in the Analysis of Taxes," NBER Chapters,in: International Economic Transactions: Issues in Measurement and Empirical Research, pages 293-320 National Bureau of Economic Research, Inc.
    3. Kenneth A. Froot, 1990. "Multinational Corporations, Exchange Rates, and Direct Investment," NBER Chapters,in: International Policy Coordination and Exchange Rate Fluctuations, pages 307-346 National Bureau of Economic Research, Inc.
    4. Lois E. Stekler & Guy V. G. Stevens, 1991. "The adequacy of U.S. direct investment data," International Finance Discussion Papers 401, Board of Governors of the Federal Reserve System (U.S.).
    5. Radhakrishnan, Suresh & Tsang, Albert, 2011. "The valuation-relevance of the foreign translation adjustment: The effect of barriers to entry," The International Journal of Accounting, Elsevier, vol. 46(4), pages 431-458.
    6. Ott, Mack, 1996. "Post Bretton Woods deviations from purchasing power parity in G7 exchange rates--an empirical exploration," Journal of International Money and Finance, Elsevier, vol. 15(6), pages 899-924, December.
    7. Kenneth A. Froot, 1991. "Japanese Foreign Direct Investment," NBER Working Papers 3737, National Bureau of Economic Research, Inc.
    8. Robert L. Conn & Andy Cosh & Paul M. Guest & Alan Hughes, 2005. "The Impact on UK Acquirers of Domestic, Cross-border, Public and Private Acquisitions," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 32(5-6), pages 815-870.
    9. Joshua Aizenman, 1991. "Foreign Direct Investment, Productive Capacity and Exchange Rate Regimes," NBER Working Papers 3767, National Bureau of Economic Research, Inc.
    10. Braunerhjelm, Pontus & Thulin, Per, 2005. "The trade-off between agglomeration forces and relative costs: EU versus the “world” Evidence from firm-level location data 1974-1998," Working Paper Series in Economics and Institutions of Innovation 30, Royal Institute of Technology, CESIS - Centre of Excellence for Science and Innovation Studies.
    11. Pontus Braunerhjelm & Per Thulin, 2009. "Agglomeration, Relative Wage Costs and Foreign Direct Investment—Evidence from Swedish MNCs 1974–1998," Journal of Industry, Competition and Trade, Springer, vol. 9(3), pages 197-217, September.
    12. Chen, Guo, 2013. "Health costs, factor productivity and foreign direct investment flows," Master's Theses 157717, University of Minnesota, Department of Applied Economics.
    13. Joshua Aizenman, 1992. "Exchange Rate Flexibility, Volatility, and the Patterns of Domestic and Foreign Direct Investment," NBER Working Papers 3953, National Bureau of Economic Research, Inc.
    14. John A. Carlson & Carol L. Osler, 1999. "Determinants of current risk premiums," Staff Reports 70, Federal Reserve Bank of New York.

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