The merits of horizontal versus vertical FDI in the presence of uncertainty

We examine the impact of uncertainty on vertical and horizontal FDI. Our model shows that greater supply uncertainty reduces the expected income from vertical FDI but increases the expected income from horizontal FDI. Greater demand uncertainty adversely affects the expected income under both production modes. Uncertainty about predatory actions by the host country is more costly to the multinational under vertical than under the horizontal mode. We examine sales by foreign affiliates of U.S. parent companies. Conditioning on host-country characteristics thought to influence FDI, we find evidence that volatility and sovereign risk have a greater negative impact on vertical FDI than on horizontal FDI. (C) 2003 Elsevier B.V. All rights reserved.