Exchange Rates and FDI: Goods Versus Capital Market Frictions

35 Pages Posted: 25 May 2006

See all articles by Claudia M. Buch

Claudia M. Buch

Deutsche Bundesbank

Joern Kleinert

University of Tuebingen - Department of Economics

Date Written: February 2006

Abstract

Economic theory provides two main explanations why changes in exchange rates can affect foreign direct investment (FDI). According to a first explanation, FDI reacts to exchange rate changes if there are information frictions on capital markets and if the investment by firms depends on their net worth (capital market friction hypothesis). According to a second explanation, FDI reacts to exchange rate changes if output and factor markets are segmented, and if firm-specific assets are important (goods market friction hypothesis). We provide a unified theoretical framework of the two explanations and test the model using German sectoral data derived from detailed firm-level data. We find greater support for the goods market friction hypothesis.

Keywords: FDI, exchange rates, net worth effects, firm-specific assets multinational firms

JEL Classification: F31, F23, F21

Suggested Citation

Buch, Claudia M. and Kleinert, Joern, Exchange Rates and FDI: Goods Versus Capital Market Frictions (February 2006). Available at SSRN: https://ssrn.com/abstract=904322 or http://dx.doi.org/10.2139/ssrn.904322

Claudia M. Buch (Contact Author)

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

Joern Kleinert

University of Tuebingen - Department of Economics ( email )

Mohlstrasse 36
D-72074 Tuebingen, 72074
Germany

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