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Causality between Financial Development and Foreign Direct Investment in Asian Developing Countries

Huy Tiet Pham, Christopher Gan and Baiding Hu
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Huy Tiet Pham: Department of Financial and Business Systems, Lincoln University, Christchurch 7647, New Zealand
Christopher Gan: Department of Financial and Business Systems, Lincoln University, Christchurch 7647, New Zealand
Baiding Hu: Department of Global Value Chains and Trade, Lincoln University, Christchurch 7647, New Zealand

JRFM, 2022, vol. 15, issue 5, 1-26

Abstract: This study investigated the linkages between foreign direct investment (FDI) and financial development measured by banks and stock markets in 30 Asian developing countries from 1986 to 2019. We used a bivariate model with Granger causality tests to test the reverse causality between FDI and financial development and multivariate models with the system generalized method of moments (GMM) estimator to identify how one factor affected the other. Our Granger test results showed a bidirectional linkage between FDI and financial development. Using the system GMM estimator, we showed that greater financial development drew more inward FDI to host countries. Similarly, local financial markets benefited from FDI by improving capital mobilization and financial services and products to intensify economic activity. Our findings suggest that, to attract FDI, policymakers should improve local banks and the stock market environment with strong institutional backgrounds to enhance foreign investors’ confidence and provide incentives to increase cross-border investments in host economies.

Keywords: Asian developing countries; foreign direct investment; Granger causality; financial development; system GMM (search for similar items in EconPapers)
JEL-codes: C E F2 F3 G (search for similar items in EconPapers)
Date: 2022
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