Strategic trade policy, cost uncertainty and FDI determinants

Yan Guo

ISU General Staff Papers from Iowa State University, Department of Economics

Abstract: The focus of my dissertation is in two areas: the relationship between optimal trade policy and demand / cost variances when the timing of investment is endogenous, and analysis of robust FDI determinants with endogenous exchange rate in the presence of model uncertainty and selection bias. In the first stream, I seek to explore the relationship by theoretical derivation and simulation. In the second stream, I examine the FDI equation by empirical analyses.My second Chapter "Strategic Trade Policy and the Investment Timing under Cost Uncertainty" seeks to examine the optimal trade policy under both demand uncertainty and cost uncertainties when the timing of investment is endogenous. Based on Albaek (1990), this Chapter adds stochastic cost structure into Dewit and Leahy (2004)'s model. An interesting result was found that when demand variance is small and there is no cost variance to the foreign firm, the home government would like to enforce home firm delay before enforcing foreign firm delay when the home firm's cost variance increases.My third Chapter "Strategic Trade Policy and the Investment Timing under Cost Uncertainty with Private Information" studies the optimal trade policy and the timing of investment under cost uncertainties and private information. It is assumed that cost random components are only observed privately by each firm and kept unknown to the other when firms decide how much to invest. We found a striking result that when there is no correlation among cost shocks, as demand uncertainty rises the government may enforce foreign firm commitment when home firm's cost variance is smaller than foreign firm's cost variance.My fourth Chapter "Robust FDI determinants with endogenous exchange rate in the presence of model uncertainty and selection bias" explores the robust FDI determinants in a general equilibrium framework with endogenous exchange rate. An empirical model of FDI decisions in a general equilibrium framework is set up, and HeckitBMA methodology is adopted suggested in Eicher et al. (2012) to deal with model uncertainty and selection bias. It is found that a monetary expansion in the host country is shown to deter new investments (extensive margin) from foreign countries.

Date: 2013-01-01
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