INVESTMENT FLOW: AN EMPIRICAL STUDY OF THE EFFECTS OF EXCHANGE RATES ON US FOREIGN DIRECT INVESTMENT INFLOWS

Abstract

This paper analyzes three main questions: 1) the effect of exchange rates on foreign direct investment (FDI) acquisition in the US, 2) the differential effects of exchange rates on FDI acquisition in the US manufacturing, services, financial, natural resources and trade industries, respectively, and 3) the asymmetric effects of foreign currency appreciations vs. foreign currency depreciations on FDI acquisition in the US. I show that exchange rates and US inward foreign direct investment are positively and significantly correlated. I argue that exchange rates affect foreign direct investment through Froot and Stein’s wealth hypothesis in which, a foreign currency appreciation increases the foreign country’s relative wealth and thus gives it a bidding advantage over the host country. In relation to the second question, I find that the relationship between exchange rates and foreign direct investment is positive and statistically significant when analyzing acquisitions in the manufacturing industry. The fact that this relationship does not hold for the other countries suggests that FDI acquisition in these industries is significantly determined by other factors. Finally, I observe that the effect of foreign currency appreciation on FDI is symmetric and proportional to that of foreign currency depreciation.