Exchange Rate Volatility and Fdi

Topics: Foreign exchange market, Exchange rate, Currency Pages: 12 (3544 words) Published: June 1, 2008

Foreign Direct Investment brings various benefits to both investing countries, or home countries, and recipient countries, or host countries. FDI transfers not only financial resources, but also technology and managerial know-how from home countries to host countries. Therefore, FDI are very important for developing countries, or emerging markets, to grow such as G.C.C countries and some Asian countries. For this reason, I tried to study the relationship between FDI and exchange rate volatility and observe how exchange rate changeability could affect the FDI positively or negatively. In this paper, I have chosen five academic papers which are related to FDI and currency exchange rate variability and I tried to present them in the following: (1) Exchange Rate, Exchange Rate Volatility and Foreign Direct Investment, (2) Untying the Gordian knot: The Multiple Links Between Exchange Rates and Foreign Direct Investment, (3) Exchange Rate Volatility and Foreign Direct Investment, (4) Why is China so Attractive for FDI? (5)The Role of Exchange Rates, Exchange Rate Volatility and Foreign Investment: International Evidence. Exchange Rate, Exchange Rate Volatility and Foreign Direct Investment By: Kozo Kiyota and Shujiro Urata

Literature review

Several empirical studies confirmed the strong impacts of exchange rate on FDI. Yoshimura and Kiyota (2003) examined the impacts of exchange rate on Japan’s FDI for different periods. These studies exposed that the appreciation of the home currency vis-à-vis the host currency encouraged FDI from the home country to the host country. Bénassy-Quéré, Fontagné and Lahrèche- Révil (2001) investigated the impacts of exchange rate volatility, which was measured by the coefficient of variation of quarterly nominal exchange rate over the past three years, on FDI from developed to developing countries for the 1984–96 periods by using annual data. They found that high exchange rate volatility discouraged FDI while the depreciation of local currency promoted FDI from developed countries. Its worth mentioning that only few studies that empirically observed the impacts of exchange rate volatility on FDI. Although the effects of the exchange rate on FDI are generally robust in that the depreciation of host currency promotes FDI inflows to that country, the impacts of exchange rate volatility on FDI have been shown to be ambiguous.

Objective of the synthesized papers

The objective of this paper is to analyse the effects of exchange rate and its volatility on Japan’s FDI by extending previous studies in several ways. Moreover, it examines the impacts of the US-dollar pegged system on FDI. Methodologies

To analyse the effects of exchange rate and its volatility on Japan’s FDI, authors extended previous studies in several ways. The Benchmark Model is used in this paper with some modifications for investigating the impacts of exchange rate volatility on FDI. Specially, the regression equation includes exchange rate volatility and exchange rate as the explanatory variables. The authors use annual FDI from Japan to its partner countries between 1990 and 2000. Also, the real exchange rate volatility is assumed to consist of two parts: one is a part explained by the failures of establishing the law of one price and the other is an unexplained part. An examination of the regional destinations of Japan’s FDI was done by comparing different regions around the world indicates that East Asia and Pacific, EU-15 and North America are three major destinations. In 2000, these three regions accounted for 88.8 per cent of Japan’s FDI. Also, the authors computed the basic statistics and the correlations of the variables such as FDI/GDP, the actual volatility and variance, and the real exchange rate volatility. Also they included other conditioning variables, such as interest rates and interest rate volatility that reflect the monetary policy and monetary uncertainty, respectively. Moreover,...
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