International Reserves and the Composition of Foreign Equity Investment

31 Pages Posted: 3 Apr 2014

See all articles by Xingwang Qian

Xingwang Qian

State University of New York, Buffalo State

Andreas Steiner

University of Osnabrueck, Institute of Empirical Economic Research

Date Written: May 2014

Abstract

This paper studies the effect of central banks' international reserve hoardings on the composition of foreign equity investment. Specifically, it examines whether reserves affect the share of foreign portfolio equity investment (PEI) in total foreign equity investment, which includes both PEI and foreign direct investment (FDI). Foreign investors' decisions regarding the location and the type of equity capital investment might be influenced by a country's level of international reserves. In a simple theoretical model, it is shown that higher reserves, thanks to their ability to lower exchange rate risk, reduce the risk premium of PEI. Hence, higher reserves are expected to increase the inflow of PEI relative to FDI. This hypothesis is tested for a sample of 76 developing countries during the period 1980–2010 using different estimation methods, model specifications and data samples. The results suggest that higher levels of reserves are associated with a larger share of PEI relative to FDI. This result points to a collateral benefit of reserves that has been neglected so far. Reserves may contribute to develop domestic financial markets and facilitate domestic firms' access to foreign portfolio equity financing. In addition, this paper finds a strong negative effect of the global financial crisis beginning in 2008 on the share of PEI, which confirms the hypothesis that PEI is more crisis‐dependent than FDI.

Suggested Citation

Qian, Xingwang and Steiner, Andreas, International Reserves and the Composition of Foreign Equity Investment (May 2014). Review of International Economics, Vol. 22, Issue 2, pp. 379-409, 2014. Available at SSRN: https://ssrn.com/abstract=2419782 or http://dx.doi.org/10.1111/roie.12113

Xingwang Qian (Contact Author)

State University of New York, Buffalo State ( email )

Classroom BLDG B232
1300 Elmwood Ave
Buffalo, NY 14222
United States
716-878-6031 (Phone)
716-878-6907 (Fax)

Andreas Steiner

University of Osnabrueck, Institute of Empirical Economic Research ( email )

Rolandstrasse 8
Osnabrück, D-49069
Germany

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