Abstract
This paper investigates the impact of price and real exchange rate volatility on Foreign Direct Investment (FDI) inflows in a panel of 10 Latin American and Caribbean countries, observed between 1990 and 2012. Both price and exchange rate volatility series are estimated through the Generalized Autoregressive Conditional Heteroscedasticity model (GARCH). Our results obtained, employing the Fixed Effects estimator, confirm the theory of hysteresis and option value, in so far as a statistically significant negative effect of exchange rate volatility on FDI is found. Price volatility, instead, turns out to be positive but insignificant. Moreover, we show that human capital and trade openness are key for attracting foreign capital. From the policy perspective, our analysis suggests the importance of stabilization policies as well as the policy of government credibility in promoting trade openness and human capital formation.
Highlights
The Organisation for Economic Co-operation and Development (OECD (2008)) [1] defines a Foreign Direct Investment Enterprise as an incorporated or unincorporated enterprise in which a foreign investor owns 10 per cent or more of the ordinary shares or voting power of an incorporated enterprise or the equivalent of an unincorporated enterprise
The Economic Commission for Latin America and the Caribbean (ECLAC) (2015) [9] explicitly calls for further research on this topic, as it is noticed that the impact of currency fluctuations on Foreign Direct Investment (FDI) is uncertain a priori and it depends on a number of factors, such as the type of investment, the origin of the investor, the characteristics of the host economy and the time horizon considered
FDI, measured as a percentage of GDP, represents the dependent variable. π and RER are price and real exchange rate volatility, both variables are expressed in logarithms; INST represents a proxy for country-specific institutional quality and it is measured on 1-to-7 scale; GDPPC stands for per capita Gross Domestic Product; TO, HC and INFRA indicate, respectively, trade openness, human capital and infrastructural development
Summary
The Organisation for Economic Co-operation and Development (OECD (2008)) [1] defines a Foreign Direct Investment Enterprise as an incorporated or unincorporated enterprise in which a foreign investor owns 10 per cent or more of the ordinary shares or voting power of an incorporated enterprise or the equivalent of an unincorporated enterprise. Despite the impact of price and exchange rate volatility on FDI inflows having been widely investigated, from both the theoretical and the empirical perspective, the evidence on Latin American and Caribbean countries is still scant. This is mainly due to scarcity of available data. The Economic Commission for Latin America and the Caribbean (ECLAC) (2015) [9] explicitly calls for further research on this topic, as it is noticed that the impact of currency fluctuations on FDI is uncertain a priori and it depends on a number of factors, such as the type of investment, the origin of the investor, the characteristics of the host economy and the time horizon considered
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