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Foreign Direct Investment and Debt Financing in Emerging Economies

Paul Luk and Tianxiao Zheng

Journal of Money, Credit and Banking, 2020, vol. 52, issue 4, 863-905

Abstract: The rich dynamics of capital flows is an important characteristic of business cycles in emerging market economies. In the data external debt is always procyclical, while FDI is procyclical only in normal times. We provide a microfounded rationale for this pattern by linking financial shocks to capital flows. For this purpose, we build a small open economy model in which firms are subject to borrowing constraints, and are either owned domestically or by foreign investors who purchase firms through FDI. During a financial crisis, the valuation gap per unit net worth between foreign and domestic investors widens, which triggers more FDI inflow. Our model produces business cycle moments consistent with empirical observations.

Date: 2020
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https://doi.org/10.1111/jmcb.12612

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Persistent link: https://EconPapers.repec.org/RePEc:wly:jmoncb:v:52:y:2020:i:4:p:863-905

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Journal of Money, Credit and Banking is currently edited by Robert deYoung, Paul Evans, Pok-Sang Lam and Kenneth D. West

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