A Dynamic Model for determining Inward Foreign ... - Business School

exchange rate between the Japanese Yen and Chinese Yuan. He suggests that the real
exchange rate is one of the significant factors affecting Japanese FDI in China (2006, 207).
What is more, Demmirbag et al use primary data from 145 affiliates of western MNfs in
Turkey via a survey for the purpose of exploring the institutional incorporation of the host
country and firm variable as determinants of the factors influencing perceptions of foreign
affiliate performance. They find that financial incentives do not have any significant impact
on the perceived performance of the affiliate (2007, 330). However, Tomlin uses the
implications of the model of investment under uncertainty to examine the relationship
between exchange rates and FDI in 207 U.S industries. He states that dollar appreciations
are positively correlated with service FDI flows into the U.S (2008, 537). Additionally,
Alfaro et al formalize a mechanism that emphasizes the role of the local financial market in
enabling FDI to promote growth through linkages. They conclude that there is an increase
in the share of high level growth in financially developed economies by using realistic
parameter value (2010, 248). Nevertheless, Arratibel et al highlight that a negative effect of
exchange rate volatility on FDI stock and negative relation between exchange rate volatility
and FDI is even more negative for more open economies (2010, 11). Thus, after reviewing
the related literature, the hypothesis is as follows:
H 3a : There is a negative relationship between financial risks and inward foreign direct
investment.
2.2.4 Stock Market Price
De Santis et al. (2004) and Klein et al. (2002) test stock market valuations as a determinant
of aggregate and firm-level FDI, respectively, but use these valuations as proxy for
traditional FDI determinants – in particular intangible assets – or do not control for
traditional FDI determinants, and therefore do not test for a strict finance-FDI effect in the
sense of Baker et al (2009). Baker et al note that relative wealth shocks of the type that
results from exchange rate changes in Froot and Stein (1991) may also originate in stock
market price misalignments. They discuss the possibility of an effect on FDI through a
‘cheap finance’ channel (source-country overvaluation) or a ‘cheap assets’ channel (targetcountry
undervaluation5), and find strong evidence in favour of a ‘cheap finance’ effect on
annual aggregate US FDI flows over the 1974–2001 period.
H 5a : There is a positive relationship between stock market price and inward foreign direct
investment.
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