THE IMPACT OF EXCHANGE RATE ON FDI AND THE INTERDEPENDENCE OF FDI OVER TIME

Abstract

We examine the impact of exchange rates on foreign direct investment (FDI) inflows into the United States in the context of a model that allows for the interdependence of FDI over time. Interdependence is modeled as a two-state Markov process where the two states can be interpreted as either a favorable or an unfavorable environment for FDI in an industry. We use unbalanced industry-level panel data from the US wholesale trade sector and our analysis yields two main results. First, we find evidence that FDI is interdependent over time. Second, under a favorable FDI environment, the exchange rate has a positive and significant effect on the average rate of FDI inflows.