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Why Do Foreigners Invest in the United States?

  • Kristin J. Forbes

    (MIT-Sloan School of Management)

Why are foreigners willing to invest almost $2 trillion/year in the United States? The answer will affect if the existing pattern of global imbalances can persist and if the United States can continue to finance its current account deficit without a major change in asset prices and returns. This paper tests various hypotheses, focusing on the factors driving private-sector investment decisions. Standard portfolio allocation models and diversification motives are poor predictors of foreign holdings of U.S. liabilities. Instead, foreigners hold greater shares of their investment portfolios in the United States if they have less developed financial markets. The magnitude of this effect is greater in lower income countries. Countries with more capital controls also invest less in U.S. equity and bond markets, and foreign investors “chase returns” in their purchases of U.S. equities (although not bonds). The empirical results showing a primary role of financial market development in driving foreign purchases of U.S. portfolio liabilities supports recent theoretical work on global imbalances.

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Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 387.

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Date of creation: 2008
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Handle: RePEc:red:sed008:387
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