Working Paper: NBER ID: w11047
Authors: Itay Goldstein; Assaf Razin
Abstract: The paper develops a model of foreign direct investments (FDI) and foreign portfolio investments (FPI). FDI is characterized by hands-on management style which enables the owner to obtain relatively refined information about the productivity of the firm. This superiority, relative to FPI, comes with a cost: a firm owned by the relatively well-informed FDI investor has a low resale price because of a "lemons" type asymmetric information between the owner and potential buyers. The model can explain several stylized facts regarding foreign equity flows, such as the larger ratio of FDI to FPI inflows in developing countries relative to developed countries, and the smaller volatility of FDI net inflows relative to FPI net inflows.
Keywords: Foreign Direct Investment; Foreign Portfolio Investment; Asymmetric Information; Liquidity; Capital Flows
JEL Codes: F3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| FDI (F23) | superior information about projects (H43) |
| superior information about projects (H43) | efficient management (D61) |
| FDI (F23) | efficient management (D61) |
| liquidity shocks (E44) | lower resale prices of FDI (F23) |
| lower resale prices of FDI (F23) | lemons problem (L15) |
| high expected liquidity needs (E41) | choose FPI (F23) |
| low liquidity needs (E41) | favor FDI (F23) |
| FPI (F23) | higher volatility than FDI (F23) |