Academic journal article Journal of Financial Management & Analysis

Foreign Direct Investment Models : Empirical Evidence from Italy

Academic journal article Journal of Financial Management & Analysis

Foreign Direct Investment Models : Empirical Evidence from Italy

Article excerpt

The authors own full responsibility for the contents of the paper.

Introduction

Many research studies have been conducted to find out whether the FDI flows could be explained by the real exchange rate behavior. This discussion might be pertinent at the macro and micro level. The first perspective might concern those who define countries' monetary policy in order to use this condition to enhance economy's attractiveness to foreign investment, and the second might be of interest to those who wish to understand better how firms define their foreign investment strategies. When evaluating projects' factors that enhance the density probability of revenues or reduce the density probability of costs, the incorporation of such information could favor the decisional process to choose in the right way the most profit-maximizing projects. It is commonly accepted that purchasing power parity suffers from misalignments in the short-run, as well as the continuous dynamic search of equilibrium in the long run. The discussion could be centered if the misalignments are opportunities to invest in assets that become therefore temporarily more advantageous, and if agents do acknowledge this fact and integrate it in their decisional process.

The firm has therefore to decide what technology to implement according to its contiguous economic parameters and the magnitude and specificity of investment in a profit-maximizing way. When we expand the company domain beyond home-country limits, these considerations assume higher complexity. The complexity arises from the fact of existing several alternatives with equal or more number of consequences to the firm's value. When considering the opportunity of internationalization the strategies might be several. A firm might choose to export, to license local representation, and stimulate local joint ventures, it may acquire local production or distribution units, or it might develop from-root local units in a foreign direct investment process. The availability to perceive the distinction between uncertainties and less certainties, will allow project evaluators to judge in "closer-to reality" basis, the relevance of a such project, and even to spend more time to develop procedures to get closer of the right-assessment of uncertainties.

In this scenario we find interesting to debate the pertinence of a greater knowledge of foreign exchange rate mechanism impact on the decisional process. Two particularities seem to be most important to distinguish: the first related with real exchange rate level or with exchange rate volatility, and the second is the recognition of the temporal analysis limit, that is acknowledging the existence of the short run and long run exchange rate behavior, and their different implication to this issue. Once again, two perspectives might be used to discuss the problem: the first relates to an analysis from the point of view of macroeconomic variables, that assume that it is expressed on those variables aggregated behaviors of individual firms, and the second comes from the project evaluation processes, where complementary variables become endogenous. We intend to increase our knowledge about the first perspective assessing its applicability to the Italian reality.

Prelude

When we gather around the majority of the attempts to explain FDI and its behavior, we came up with a big set of explanatory variables. FDI has been explained by some, by relative costs that would result in advantages to firms that could not be ignored, and that this benefit could arise either from inputs (relative labor and capital costs) necessary to production, or from assets, not directly consumed in production but necessary to put up the production line. Amongst all these factors it was also taken into consideration the effect of real exchange rate on the foreign direct investment and those studies usually took two paths: on one perspective it was analyzed the impact of exchange rate level relating this problem to the issue of input and asset relative pricing; and on the other addressing the real exchange rate volatility with its impact on firm's decision regarding flexibility and uncertainty of sunk costs. …

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