Working Paper: NBER ID: w13723
Authors: Itay Goldstein; Assaf Razin; Hui Tong
Abstract: We examine the choice between Foreign Direct Investment and Foreign Portfolio Investment at the level of the source country. Based on a theoretical model, we predict that (1) source countries with higher probability of aggregate liquidity crises export relatively more FPI than FDI, and (2) this effect strengthens as the source country's capital market transparency worsens. To test these hypotheses, we apply a dynamic panel model and examine the variation of FPI relative to FDI for 140 source countries from 1985 to 2004. Our key variable is the probability of an aggregate liquidity crisis, estimated from a Probit model, as proxied by episodes of economy-wide sales of external assets. Consistent with our theory, we find that the probability of a liquidity crisis has a strong effect on the composition of foreign equity investment. Furthermore, greater capital market opacity in the source country strengthens the effect of the crisis probability.
Keywords: liquidity; institutional quality; foreign direct investment; foreign portfolio investment; capital markets
JEL Codes: F2; F23; F3; G11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| probability of liquidity crisis (G33) | FPI/FDI ratio (F23) |
| lower capital market transparency (G18) | effect of liquidity crisis probability on FPI/FDI ratio (F65) |