Multinationals as Arbitrageurs: The Effect of Stock Market Valuations on Foreign Direct Investment
Posted: 30 Apr 2007 Last revised: 12 Jan 2009
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: foreign direct investment, fdi, multinational, flow
JEL Classification: F21, F23, G15, G34, G31, E22, O16
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