Abstract
AbstractWe study an underexplored research question, namely whether financial market development in both host and source countries has an effect on bilateral stocks of foreign direct investment (FDI) and, particularly, whether the effect of financial market development in one member of the country pair conditions the effect of financial market development in the other member. We estimate gravity‐type models in a global sample of 43 source and 137 host countries over the period 2001–12. We address reverse causality concerns by restricting the sample to observations where reverse causality, if existent, should be less relevant. Our major and robust findings are that bilateral FDI increases with better developed financial markets in both the host and the source country and that for developing host countries, financial market development in source and host countries functions as substitutes for each other.
Highlights
There is an emerging consensus that financial market development (FMD) increases foreign direct investment (FDI).1 studies have typically addressed FMD on just one side of the source–host pair, leaving it unclear whether what matters for FDI is only FMD in the host countries, only in the source countries or in both host and source countries
Column (1) of Table 1 shows results for the effects on FDI of FMD in the source and the host country, while we enter the interaction between FMD in both countries of a pair in separate estimations reported in column (2)
We find that bilateral FDI increases with better developed financial markets in the host and the source country and FMD in both countries of a pair plays a important role in substantive terms
Summary
There is an emerging consensus that financial market development (FMD) increases foreign direct investment (FDI). studies have typically addressed FMD on just one side of the source–host pair, leaving it unclear whether what matters for FDI is only FMD in the host countries, only in the source countries or in both host and source countries. There is an emerging consensus that financial market development (FMD) increases foreign direct investment (FDI).. We know of just two previous studies considering the role of financial market conditions in both host and source countries for bilateral FDI, namely Coeurdacier, Santis, and Aviat (2009) and Desbordes and Wei The potential conditionality between host country FMD and source country FMD is relevant for host countries that have remained on the sidelines in the global competition for FDI, such as many developing countries, since typically they score poorly on FMD whereas many, though by no means all, of the countries that could potentially invest in them score highly on FMD.
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