Geopolitical Risk and the Location Choice of Chinese Outward FDI

Abstract

This study examines the impact of geopolitical risk on the location choice of Chinese outward foreign direct investment (OFDI). We construct a novel firm-destination-month data by merging cross-border investments of Chinese listed firms with the Geopolitical Risk index developed by Caldara and Iacoviello (2022). Our mixed logit model analysis reveals a positive link between host country geopolitical risk and Chinese OFDI. This finding is driven by the growth options effect, which incentivizes risk-taking for FDI seeking natural resources and strategic assets. This positive effect outweighs the deterrence from precautionary consumption, which discourages market-seeking FDI, and the real options effect, which highlights investment irreversibility. Moreover, China's unique economic and institutional characteristics, including extensive export experience, underdeveloped domestic institutions, and government support, help explain the positive effect of geopolitical risk on Chinese OFDI. This effect of geopolitical risk has also evolved with China's shifting geopolitical landscape, rising during early global integration, declining after the One Belt One Road initiative, and resurging with recent tensions.

Keywords: Geopolitical risk, OFDI, Location choice, China, Mixed logit

JEL Classification: F21, F23, F51, H56, N40