Foreign direct investment, exchange rate pass-through, and exchange rate volatility: A perspective of spatial panel data

Exchange Rate Pass-Through and Pricing-to-Market behavior is an important consideration in International Economics and Industrial Organization Theory. The goal of my dissertation is to provide both a theoretically and empirically justified definition of the Foreign Direct Investment (FDI) effect on the extent of exchange rate pass-through. In the theoretical part, the Cournot fashion of international duopoly market is constructed to explain reaction functions between a local firm in the host country and a foreign multinational. Preliminary results of the theoretical framework indicate that FDI will affect on lowering degree of exchange rate pass-through and generates higher degree of Pricing-to-Market behavior. I also extend the international duopoly model into a two-period approach with observing of exchange rate volatility. The results of this extension support the previous literature by Froot and Klemperer (1989) and Tivig (1996) in that the degree of exchange rate pass-through behavior will be lowest if the exchange rate performs temporally than when it is permanent. By observing the flows of foreign direct investment and exchange rate volatility, the theoretical results also predict that the volume of foreign direct investment flows will be higher if exchange rate changes are temporary than if it is permanent.; The second part of my dissertation provides an empirical study by estimating the fixed-effect panel data model of exporters with multi-destination by observing samples of five U.S. exporting industries based on the 4-digit SIC index. I approach the ideas of spatial econometrics with the belief that disturbance terms are possible to spatially correlate across countries, based on geographic proximity measure. The empirical part of this dissertation, therefore, provides the idea of using the perspective of spatial econometrics in the context of exchange rate pass-through and Pricing-to-Market behavior. The spatial panel data procedure called “fully restricted average estimation” are applied from the previous works of Druska and Horrace (2001) to follow condition that time variables T is small while country variables is large. The estimated results show that all types of foreign direct investment affects on lowering degree of pass-through while Joint Venture generate the most significant prediction and Division generate the least. The effect of having the first foreign operation in local markets is not significant to the degree of pass-through. The monetary-unit FDI also support the results that foreign direct investment affects are lower the degree of pass-through. Moreover, with observing temporary exchange rates, degree of exchange rate pass-through will be lower in the complete and more than complete offset than in partial offset of exchange rates change.; Finally, my dissertation continues to discuss the policy implications that should be considered based on this study. It might also be useful for the policymakers in host countries to understand the implementations toward international trade policy, monetary policy, and policy development on foreign direct investment inflows. Nevertheless, the methodology of this research may not be well suited to an environment in which competitors are changing rapidly. That appears to be the state of interest in many international markets, which can be the main discussion in future researches.