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RFS Advance Access originally published online on March 19, 2008
Review of Financial Studies 2009 22(1):337-369; doi:10.1093/rfs/hhn027
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© The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org

Multinationals as Arbitrageurs: The Effect of Stock Market Valuations on Foreign Direct Investment

Malcolm Baker
Harvard Business School and NBER

C. Fritz Foley
Harvard Business School and NBER

Jeffrey Wurgler
NYU Stern School of Business and NBER

Send correspondence to Jeffrey Wurgler, NYU Stern School of Business and NBER, 44 West 4th St., Suite 9-190, New York, NY 10012; telephone: 212-998-0367; e-mail: jwurgler{at}stern.nyu.edu.

JEL Classification: F15, F21, F23, G31, G34


  Abstract

Empirical evidence of imperfect integration across world capital markets suggests a role for cross-border arbitrage by multinationals. Consistent with multinational arbitrage as a determinant of foreign direct investment (FDI) patterns, we find that FDI flows increase sharply with source-country stock market valuations—particularly the component of valuations that is predicted to revert the next year, and particularly in the presence of capital account restrictions that limit other mechanisms of cross-country arbitrage. The results suggest the existence of a cheap financial capital channel in which FDI flows reflect, in part, the use of relatively low-cost capital available to overvalued parents in the source country.

We thank Yakov Amihud, Kobi Bodoukh, Kathryn Dewenter, Cam Harvey, Rocky Higgins, Jim Hines, Terrance Odean, Paige Ouimet, Jack Porter, Michael Schill, Henri Servaes, Andrei Shleifer, Jeremy Stein, Paul Wachtel, Bernie Yeung, anonymous referees, and seminar participants at Harvard, the NBER ITI Summer Institute, NYU, the Salomon Center at NYU Finance, UCLA, University of North Carolina-Duke Corporate Finance Conference, and University of Washington for helpful comments. We also thank Ryan Taliaferro and Maggie Zhou for excellent research assistance. Baker and Foley thank the Division of Research of the Harvard Business School for financial support.


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