Intertemporal Incentives, Equilibrium Selection, and Rational Investment Collapse

Maciej Dudek

Eastern Economic Journal, 2016, vol. 42, issue 3, 428-440

Abstract: In this paper, we model the process of international investment flows when agents face strategic motives. We show in a fully rational framework that foreign investment crises can occur when the availability of foreign funds is higher than normal. Specifically, we illustrate, in a framework with multiple Pareto-rankable equilibria, that a transition to an inferior equilibrium culminating in a foreign investment crisis can occur when the availability of foreign capital is higher than normal and is expected to be only temporary. We show that a temporary and higher than normal level of availability of foreign funds alters intertemporal incentives and makes the sustainability of a Pareto-superior outcome less likely and thus allows for the occurrence of foreign investment crises.

Date: 2016
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