Multinational firms, monopolistic competition and foreign investment uncertainty

Arunish Chawla

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: This is a model of multinational firms, which introduces option value of foreign direct investment, into a framework of Dixit-Stiglitz type monopolistic competition. Starting from a pure trading equilibrium and solving for the optimal investment rule gives a scale-up factor which implies existence of a wedge between markup revenues and foreign investment costs. Greater volatility and risk aversion increase this scale-up over foreign investment costs implying a delay in the exercise of FDI option, while growing market size and national income facilitate early exercise. The model is extended to include a Poisson jump process, which has policy implications for FDI reforms and explains ‘wait and watch’ behaviour of multinational firms better than a pure comparative advantage-trade cost framework does. While investment under uncertainty literature is based on the theory of call options, I solve ‘FDI option’ as a put option, thereby also enriching the theory of real options.

Keywords: Multinational firm; monopolistic competition; foreign investment uncertainty; FDI option (search for similar items in EconPapers)
JEL-codes: F21 F23 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2008-04
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