Strategic Foreign Direct Investment and Exchange-Rate Uncertainty

Hongmo Sung and Harvey Lapan

International Economic Review, 2000, vol. 41, issue 2, 411-23

Abstract: We investigate how exchange-rate uncertainty affects the foreign direct investment decision of a risk-neutral multinational firm (MNF). We assume the firm can open plants, each with decreasing average costs, in two different countries. Under certainty, the MNF would open only one plant. We demonstrate that with sufficient exchange-rate volatility, the firm can increase expected profits by opening several plants. We also show that if the MNF faces a competitor in the foreign market, the exchange risk, by inducing the MNF to open plants in both markets, may prevent entry by the local competitor. Copyright 2000 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

Date: 2000
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