Does exchange rate uncertainty affect foreign direct investment? An empirical analysis of the Swedish case

University essay from Handelshögskolan i Stockholm/Institutionen för nationalekonomi

Author: Nils Kottmann; [2014]

Keywords: Exchange rate volatility; GARCH; FDI;

Abstract: The purpose of this thesis is to study empirically what the effect of exchange rate volatility is on foreign direct investment (FDI) stock in Sweden, as well as on Swedish FDI stock abroad. To this date, neither empirical nor theoretical research has reached consensus on the nature of this effect. I test this relationship through panel data fixed-effects estimation techniques with Driscoll and Kraay (1998) corrected standard errors in a gravity equation framework for the period between 1993-2011. I choose control variables that have performed consistently well across a range of FDI studies and use a conditional measure of exchange rate volatility - GARCH - which is used in financial contexts. I find strong evidence that exchange rate volatility has a significant positive effect on both inward as well as outward FDI stock. However, this effect seems to become weaker over time in the case of outward FDI. In addition, I find some evidence that Swedish multinationals consider the volatility between the krona and several major currencies when making investment decisions.

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