Risk, Returns, and Multinational Production

49 Pages Posted: 17 Mar 2010

See all articles by Jose L. Fillat

Jose L. Fillat

Federal Reserve Banks - Federal Reserve Bank of Boston

Stefania Garetto

Boston University

Date Written: March 11, 2010


This paper starts by unveiling a new empirical regularity: multinational corporations tend to exhibit systematically higher returns and earnings yields than non-multinational firms. Within non-multinationals, exporters tend to have higher earnings yields and returns than firms selling only in their domestic market. To explain this pattern, we develop a real option value model where firms are heterogeneous in productivity, and have to decide whether and how to sell in a foreign market where demand is risky. Firms can serve the foreign market through trade or foreign direct investment, thus becoming multinationals. Multinational firms are more exposed to risk: following a negative shock, they are reluctant to exit the foreign market because they would forgo the option premium (sunk cost) that they paid to become multinationals. The theory provides a complementary explanation for the cross section of returns by exploiting the production side from an international point of view. We calibrate the model to match U.S. export and FDI dynamics, and use it to explain cross-sectional differences in earnings yields and returns.

Keywords: Multinational firms, option value, cross-sectional returns

JEL Classification: F12, F23, G12

Suggested Citation

Fillat, Jose L. and Garetto, Stefania, Risk, Returns, and Multinational Production (March 11, 2010). AFA 2011 Denver Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1571331 or http://dx.doi.org/10.2139/ssrn.1571331

Jose L. Fillat (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Boston ( email )

600 Atlantic Avenue
Boston, MA 02210
United States
617-973-3342 (Phone)
617-5735445 (Fax)

HOME PAGE: http://www.bos.frb.org/economic/econbios/fillat.htm

Stefania Garetto

Boston University ( email )

270 Bay State Road
Boston, MA 02215
United States

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