Stock Market Valuations and Foreign Direct Investment
42 Pages Posted: 4 Nov 2008
Date Written: December 2004
We outline and test two theories of foreign direct investment based on capital market mispricing. The â¬Scheap assetsâ¬? or â¬Sfire-saleâ¬? theory considers FDI inflows as the purchase of undervalued host country assets, while the â¬Scheap financial capitalâ¬? theory views FDI outflows as a natural use of the relatively low-cost capital available to overvalued firms in the source country. The results are consistent with the cheap financial capital theory: FDI flows are unrelated to host country stock market valuations, as measured by the aggregate market-to-book-value ratio, but are strongly positively related to source country valuations and negatively related to future source country stock returns, especially when capital account restrictions limit cross-country arbitrage.
Suggested Citation: Suggested Citation