Multinational firms, monopolistic competition and foreign investment uncertainty

Chawla, Arunish (2008) Multinational firms, monopolistic competition and foreign investment uncertainty. CEPDP (866). London School of Economics and Political Science. Centre for Economic Performance, London, UK. ISBN 9780853282624

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Abstract

This is a model of multinational firms, which introduces option value of foreign direct investment, into a framework of Dixit-Stiglitz type monopolistic competition. Starting from a pure trading equilibrium and solving for the optimal investment rule gives a scale-up factor which implies existence of a wedge between markup revenues and foreign investment costs. Greater volatility and risk aversion increase this scale-up over foreign investment costs implying a delay in the exercise of FDI option, while growing market size and national income facilitate early exercise. The model is extended to include a Poisson jump process, which has policy implications for FDI reforms and explains ‘wait and watch’ behaviour of multinational firms better than a pure comparative advantage-trade cost framework does. While investment under uncertainty literature is based on the theory of call options, I solve ‘FDI option’ as a put option, thereby also enriching the theory of real options.

Item Type:	Monograph (Discussion Paper)
Official URL:	http://cep.lse.ac.uk
Additional Information:	© 2008 Arunish Chawla
Divisions:	Centre for Economic Performance
Subjects:	H Social Sciences > HG Finance H Social Sciences > HD Industries. Land use. Labor
JEL classification:	F - International Economics > F2 - International Factor Movements and International Business > F21 - International Investment; Long-Term Capital Movements F - International Economics > F2 - International Factor Movements and International Business > F23 - Multinational Firms; International Business
Date Deposited:	17 Jul 2008 13:37
Last Modified:	15 Sep 2023 23:11
URI:	http://eprints.lse.ac.uk/id/eprint/19592

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