Correlation aversion in foreign direct investment

Navruz Khotamov and Naoto Jinji

Finance Research Letters, 2025, vol. 74, issue C

Abstract: Decisions under risk are often multidimensional, where the preferences of the investor depend on several factors. Investment theory implies that in the presence of different shocks, the correlation between these shocks is important. This study analyzes the relationship between the correlation of two shocks and foreign direct investment (FDI). The sources of shocks, in this study, are related to demand and exchange rate in the destination market. Constructing large panel data on industry-level FDI, we analyze FDI under correlation risk. We show that in the presence of two shocks, industry-level FDI flows exhibit correlation aversion and that the correlation of two distinct shocks explains significant variation in geographic allocation of FDI at the industry-level.

Keywords: Correlation aversion; FDI; Exchange rate shocks; Demand shocks (search for similar items in EconPapers)
JEL-codes: D81 E32 F23 F44 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:74:y:2025:i:c:s1544612324017574

DOI: 10.1016/j.frl.2024.106728

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