Volatility of FDI and Portfolio Investments: The Role of Information, Liquidation Shocks and Transparency

43 Pages Posted: 5 Nov 2002

See all articles by Itay Goldstein

Itay Goldstein

University of Pennsylvania - The Wharton School - Finance Department

Assaf Razin

Tel Aviv University - Eitan Berglas School of Economics; National Bureau of Economic Research (NBER); CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

Date Written: August 2002

Abstract

The paper develops a model of foreign direct investments (FDI) and foreign portfolio investments. FDI is characterized by hand-on management style which enables the owner to obtain relatively refined information about the productivity of the firm. This superiority, relative to portfolio investments, comes with a cost: A firm owned by the relatively well-informed FDI investor has a low resale price because of asymmetric information between the owner and potential buyers. Consequently, investors, who have a higher (lower) probability of getting a liquidity shock that forces them to sell early, will invest in portfolio (direct) investments. This result can explain the greater volatility of portfolio investments relative to direct investments. We show that this pattern may become weaker as the transparency in the capital market or the corporate governance in the host economy increase.

Keywords: FDI, Capital Flows, Transparency, Asymmetric Information, Corporate Governance

Suggested Citation

Goldstein, Itay and Razin, Assaf, Volatility of FDI and Portfolio Investments: The Role of Information, Liquidation Shocks and Transparency (August 2002). Available at SSRN: https://ssrn.com/abstract=326960 or http://dx.doi.org/10.2139/ssrn.326960

Itay Goldstein (Contact Author)

University of Pennsylvania - The Wharton School - Finance Department ( email )

The Wharton School
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Assaf Razin

Tel Aviv University - Eitan Berglas School of Economics ( email )

P.O. Box 39040
Ramat Aviv, Tel Aviv, 69978
Israel
+972 3 640 7303 (Phone)
+972 3 640 9908 (Fax)

National Bureau of Economic Research (NBER) ( email )

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CESifo (Center for Economic Studies and Ifo Institute)

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Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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