The Effect of Exchange Rate Risk on U.S. Foreign Direct Investment: An Empirical Analysis

Dresden Discussion Paper in Economics No. 09/08

32 Pages Posted: 21 May 2008

See all articles by Christian W. Schmidt

Christian W. Schmidt

Leibniz Institute of Ecological and Regional Development (IOER) - Dresden Leibniz Graduate School (DLGS)

Udo Broll

Dresden University of Technology - Faculty of Economics and Business Management

Date Written: April 8, 2008

Abstract

This paper empirically analyzes the impact of exchange rate uncertainty, exchange rate movements and expectations on foreign direct investment (FDI). Two competing specifications of exchange rate volatility are examined. The investigation is based on a cross-section time-series data set of U.S. outward FDI by industries to six major partner countries for the period 1984-2004. Using the standard deviation of the real exchange rate as a measure of risk it is found that exchange rate uncertainty has a discouraging effect on FDI flows across all industries. This is contrasted when applying an alternative risk specification defined as the unexplained part of real exchange rate volatility. Now, results show a clear distinction between non-manufacturing and manufacturing industries. U.S. FDI outflows in nonmanufacturing industries exhibit a positive correlation with increased exchange risk, whereas this relationship is negative for manufacturing industries in the underlying sample. A real appreciation of host-country currency was associated with higher FDI flows, while expectations about an appreciation showed a negative result.

Keywords: Foreign direct investment, real exchange rate risk, volatility

JEL Classification: F21, F23

Suggested Citation

Schmidt, Christian Walter and Broll, Udo, The Effect of Exchange Rate Risk on U.S. Foreign Direct Investment: An Empirical Analysis (April 8, 2008). Dresden Discussion Paper in Economics No. 09/08, Available at SSRN: https://ssrn.com/abstract=1135687 or http://dx.doi.org/10.2139/ssrn.1135687

Christian Walter Schmidt (Contact Author)

Leibniz Institute of Ecological and Regional Development (IOER) - Dresden Leibniz Graduate School (DLGS) ( email )

Weberplatz 1
Dresden, 01217
Germany
+49 (0)351 46 79 263 (Phone)

Udo Broll

Dresden University of Technology - Faculty of Economics and Business Management ( email )

Mommsenstrasse 13
Dresden, D-01062
Germany

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