Foreign direct investment and the correlation between cost and revenue

Avner Bar‐Ilan and Ivan Borodko

Review of International Economics, 2019, vol. 27, issue 4, 1252-1267

Abstract: This paper studies irreversible investment in the presence of uncertain revenue and uncertain cost of production. Using methodology of real options, we find the threshold markup of price over cost that triggers investment. When the processes for revenue and cost are negatively correlated, the standard result that uncertainty delays investment always holds. However, when these two processes are positively correlated, greater uncertainty of revenue or cost might accelerate investment. As less correlated cost and revenue, vertical FDI is less desirable than producing at home, but horizontal FDI that brings production to the output market is an advantage.

Date: 2019
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