The Effect of Capital Controlson Foreign Direct Investment Decisions Under Country Risk with Intangible Assets

Kinga Elo

No 2007/079, IMF Working Papers from International Monetary Fund

Abstract: This paper examines how capital controls affect FDI decisions and how the impact of these restrictive measures varies with different levels of country risk. We construct a model of firms' FDI decisions, broadly in Dunning's "eclectic theory" framework, using "real options" to emphasize economic uncertainty and country risk. Numerical results of the model take the form of "quality statistics" that uncover the underlying dynamics hidden in the aggregate data that is responsible for the low performance of recent empirical studies. We find that increasing levels of capital controls reduce the life-span of FDI investments at each level of country risk and foreign investors' willingness towards risk sharing increases. We reveal a significant interaction between capital control and country risk, resulting in a nonlinear relationship between these and the volatility and volume statistics. We estimate a standard cross-sectional model that provides strong support for our theoretical findings.

Keywords: WP; country risk; capital control; Foreign direct investments; capital controls; decisions under uncertainty; FDI flow; fixed cost; FDI project; transaction costs; FDI volatility; decision model; GDP equation; macro FDI datum; FDI investment; country risk parameter; FDI decision; decision problem; Foreign direct investment; Capital flows; Business environment; Foreign corporations; Global (search for similar items in EconPapers)
Pages: 62
Date: 2007-04-01
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Citations: View citations in EconPapers (7)

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