Why Do Foreigners Invest in the United States?
Kristin J. Forbes
Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER); Bank of England - Monetary Policy Committee
June 16, 2009
MIT Sloan Research Paper No. 4701-08
Why are foreigners willing to invest almost $2 trillion per year in the United States? The answer affects if the existing pattern of global imbalances can persist and if the United States can continue to finance its current account deficit without a major change in asset prices and returns. This paper tests various hypotheses and finds that standard portfolio allocation models and diversification motives are poor predictors of foreign holdings of U.S. liabilities. Instead, foreigners hold greater shares of their investment portfolios in the United States if they have less developed financial markets. The magnitude of this effect decreases with income per capita. Countries with fewer capital controls and greater trade with the United States also invest more in U.S. equity and bond markets, and foreign investors chase returns in their purchases of U.S. equities (although not bonds). The empirical results showing a primary role of financial market development in driving foreign purchases of U.S. portfolio liabilities supports recent theoretical work on global imbalances.
Number of Pages in PDF File: 51
Keywords: home bias, foreign investment, portfolio flows, capital flows, U.S. current account
JEL Classification: F2, F3, F4, G1
Date posted: April 14, 2008 ; Last revised: June 30, 2009