Exchange rates and foreign direct investment: A note

In "Exchange Rates and Direct Investment: An Imperfect Capital Markets Approach," Kenneth Froot and Jeremy Stein (1991) develop a new finance-based theory to answer an old question-the relationship, if any, between the flow of foreign direct investment and the exchange rate. Their theory, based on the possibility that a foreign firm's borrowing opportunities for financing a U.S. acquisition may be a function of its net worth in dollars, implies a negative relationship between a dollar appreciation and direct investment inflows into the United States. Empirically, the authors find statistically significant evidence of the implied negative relationship for quarterly and annual time series regressions, over the period 1973-88. The major purpose of this note is to show that this empirical support for the theory is weak. The authors' regressions show evidence of serious instability, and the significant negative relationship between direct investment inflows and the value of the dollar disappears for important subperiods of the 1973-88 period and for the sample period extended through 1991. (C) 1998 Society for Policy Modeling. Published by Elsevier Science Inc.