Liquidity, Institutional Quality and the Composition of International Equity Outflows / Itay Goldstein, Assaf Razin, Hui Tong.

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Goldstein, Itay

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Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w13723.Publication details: Cambridge, Mass. National Bureau of Economic Research 2008.Description: 1 online resource: illustrations (black and white)Subject(s):

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Abstract: We examine the choice between Foreign Direct Investment and Foreign Portfolio Investment at the level of the source country. Based on a theoretical model, we predict that (1) source countries with higher probability of aggregate liquidity crises export relatively more FPI than FDI, and (2) this effect strengthens as the source country's capital market transparency worsens. To test these hypotheses, we apply a dynamic panel model and examine the variation of FPI relative to FDI for 140 source countries from 1985 to 2004. Our key variable is the probability of an aggregate liquidity crisis, estimated from a Probit model, as proxied by episodes of economy-wide sales of external assets. Consistent with our theory, we find that the probability of a liquidity crisis has a strong effect on the composition of foreign equity investment. Furthermore, greater capital market opacity in the source country strengthens the effect of the crisis probability.

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Working Paper	Biblioteca Digital	Colección NBER	nber w13723 (Browse shelf(Opens below))	Not For Loan

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Previous	nber w13720 Optimal Savings Distortions with Recursive Preferences /	nber w13721 How Does Corporate Governance Risk at Home Affect Investment Choices Abroad? /	nber w13722 Complementarity and the Measurement of Individual Risk Tradeoffs: Accounting for Quantity and Quality of Life Effects /	nber w13723 Liquidity, Institutional Quality and the Composition of International Equity Outflows /	nber w13724 Variable Rare Disasters: An Exactly Solved Framework for Ten Puzzles in Macro-Finance /	nber w13725 Religion, Terrorism and Public Goods: Testing the Club Model /	nber w13726 Footnotes Aren't Enough: The Impact of Pension Accounting on Stock Values /	Next

January 2008.

We examine the choice between Foreign Direct Investment and Foreign Portfolio Investment at the level of the source country. Based on a theoretical model, we predict that (1) source countries with higher probability of aggregate liquidity crises export relatively more FPI than FDI, and (2) this effect strengthens as the source country's capital market transparency worsens. To test these hypotheses, we apply a dynamic panel model and examine the variation of FPI relative to FDI for 140 source countries from 1985 to 2004. Our key variable is the probability of an aggregate liquidity crisis, estimated from a Probit model, as proxied by episodes of economy-wide sales of external assets. Consistent with our theory, we find that the probability of a liquidity crisis has a strong effect on the composition of foreign equity investment. Furthermore, greater capital market opacity in the source country strengthens the effect of the crisis probability.