Foreign Investment, Currency Hedging, and the Feldstein Paradox

Ranjit Sau
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Ranjit Sau: School of Management, New Jersey Institute of Technology, Postal: Newark, NJ 07102-1982 USA http://management.njit.edu/ ,, http://management.njit.edu/

Economia Internazionale / International Economics, 1997, vol. 50, issue 1, 99-110

Abstract: Feldstein (1994) argues that the practice of hedging the exchange risk of an overseas investment through the currency market can offset a gross cross-border transfer of capital, and leave no trace of net international capital movement. Thus what is done by the capital market is undone by the currency market. We call it the Feldstein paradox. This paper notes that, if so, the volume of foreign portfolio capital in the Feldstein model is indeterminate. Furthermore, the paper distinguishes between direct investment and portfolio investment. Macroeconomic balance re¬quires, it is proved, a two-fold condition: a well-specified proportionate relationship between these two kinds of capital, and also between the country’s export earnings and the total volume of foreign capital. It transpires that there exists a stable, steady-state for the economy with inflows of foreign capital in appropriate volume and correct composition.

Date: 1997
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