An Information-Based Trade-off Between Foreign Direct Investment and Foreign Portfolio Investment: Volatility, Transparency and

Assaf Razin and Itay Goldstein

No 3747, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: The Paper develops a model of foreign direct investments (FDI) and foreign portfolio investments. FDI is characterized by hands-on management style that enables the owner to obtain relatively refined information about the productivity of the firm. This superiority, relative to portfolio investments, comes with a cost: a firm owned by the relatively well-informed FDI investor has a low resale price because of ?lemons? type asymmetric information between the owner and potential buyers. Consequently, investors who have a higher (lower) probability of getting a liquidity shock that forces them to sell early will invest in portfolio (direct) investments. This result can explain the greater volatility of portfolio investments relative to direct investments. Motivated by empirical evidence, we show that this pattern may be weaker in developed economies that have higher levels of transparency in the capital market and better corporate governance. We also study welfare implications of the model.

JEL-codes: F00 F20 F30 (search for similar items in EconPapers)
Date: 2003-02
New Economics Papers: this item is included in nep-ifn
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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