Does Real Exchange Rate Volatility Affect Foreign Direct Investment? Evidence from Four Developed Economies

Abstract

This study examines the impact of shocks to exchange rate uncertainty (volatility) on foreign direct investment (FDI) in Canada, Japan, the United Kingdom, and the United States. The analysis is conducted using vector autoregressive models that contain the price level, real output, the real exchange rate, the volatility of the real exchange rate, the interest rate, and FDI. The results from variance decompositions yield public policy implications. In Canada, Japan, and the United States, innovations to exchange rate uncertainty explain significant portions of the forecast error variance in FDI at longer time horizons. The impulse response functions indicate that, to the extent that shocks to exchange rate volatility have an impact on FDI, the impact is positive and takes place with a lag.

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