Revisiting the Fdi-Foreign Exchange Debate: Is the Effect One of Wealth or Input Costs

Abstract

There is a debate in the extant literature about the role that foreign exchange rates play in the foreign direct investment (FDI) decision by investors. In this paper, I show that allowing for autocorrelation in FDI and exchange rates through the use of a VAR model removes the significance associated with prior studies found between the two variables, suggesting there is a spurious correlation between them. In this paper, I replicate Froot and Stein’s (1991) study linking FDI and foreign exchange rates finding similar results. Then using the same data I run VAR models allowing for autocorrelation in each variable and endogenous interactions which show the relationship no longer holds. This paper contributes to the scholarly debate regarding FDI and exchange rates by showing that more robust econometric modeling reveals inconsistencies in the extant literature.

Keywords: International investment, econometrics, VAR models, foreign currency

JEL Classification: F21