Multinationals as Arbitrageurs: The Effect of Stock Market Valuations on Foreign Direct Investment

63 Pages Posted: 2 Nov 2005 Last revised: 12 Aug 2008

Malcolm P. Baker

Harvard Business School; National Bureau of Economic Research (NBER)

C. Fritz Foley

Harvard Business School; National Bureau of Economic Research (NBER)

Jeffrey Wurgler

NYU Stern School of Business; National Bureau of Economic Research (NBER)

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Date Written: May 2004

Abstract

Empirical evidence of imperfect integration across world capital markets suggests a role for cross-border arbitrage by multinationals. Consistent with multinational arbitrage as a determinant of foreign direct investment (FDI) patterns, we find that FDI flows increase sharply with source-country stock market valuations-particularly the component of valuations that is predicted to revert the next year, and particularly in the presence of capital account restrictions that limit other mechanisms of cross-country arbitrage. The results suggest the existence of a cheap financial capital channel in which FDI flows reflect, in part, the use of relatively low- cost capital available to overvalued parents in the source country.

Keywords: Corporate investment, inefficient markets, behavioral finance, foreign direct investment, international finance

JEL Classification: G31

Suggested Citation

Baker, Malcolm P. and Foley, C. Fritz and Wurgler, Jeffrey, Multinationals as Arbitrageurs: The Effect of Stock Market Valuations on Foreign Direct Investment (May 2004). Available at SSRN: https://ssrn.com/abstract=556127 or http://dx.doi.org/10.2139/ssrn.556127

Malcolm P. Baker (Contact Author)

Harvard Business School ( email )

Boston, MA 02163
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HOME PAGE: http://www.people.hbs.edu/mbaker

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C. Fritz Foley

Harvard Business School ( email )

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Morgan 270C
Boston, MA 02163
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National Bureau of Economic Research (NBER)

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Jeffrey A. Wurgler

NYU Stern School of Business ( email )

Stern School of Business
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New York, NY 10012-1126
United States
212-998-0367 (Phone)
212-995-4233 (Fax)

HOME PAGE: http://www.stern.nyu.edu/~jwurgler/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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