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

Kenneth Froot and Jeremy Stein

No 2914, NBER Working Papers from National Bureau of Economic Research, Inc

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.

Date: 1989-03
Note: ME ITI IFM
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Published as The Quarterly Journal of Economics, Vol. CVI, No. 427, Iss. 4, pp. 1191-121 7, (November 1991).

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