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Abstract
This thesis consists of three self-contained chapters on International capital flows, employing a search theoretic approach.
In Chapter 1, we examine the decision to invest across borders in the presence of costly information acquisition and determine the propagation mechanism for shocks that arises in the presence of search frictions. The investment process is embedded in a two sector small open-economy framework. The dynamics in foreign investment flows is shown to result in comovements in real exchange rates, consumption and the current account that resemble the experience of several Latin American countries starting in the late nineteen-eighties. A standard q model of investment generates counterfactual predictions in our framework. The heterogeneity in investment that emerges allows us to analyze the gross flows of investment creation and destruction that underlie net flow data and identify the source of variability in foreign investment.
Chapter 2 presents a theoretical investigation of the interaction between the financing decision of foreign investors in the presence of heterogeneous domestic firms and the endogenous determination of domestic industry productivity. The selective formation of joint ventures between foreign equity investors and domestic firms and the intra-industry reallocation of profits that emerges is shown to be in accordance with empirical evidence. More significantly, we demonstrate that the pattern of foreign direct investment can raise average industry productivity through a churning process that causes the least productive firms to exit. This channel differs from the conventionally argued (and empirically tested) mechanism of direct productivity spillovers. The welfare of labor supplying consumers is also shown to be higher in an economy where investment is non-selective, despite average productivity being lower in this equilibrium as compared to a selective investment equilibrium
Chapter 3 explores the behavior of investment when the decisions of investors create congestion effects by reducing the likelihood of finding high return projects in the economy. We show that this can generate multiple equilibria paths and investment flows can therefore differ between countries with similar fundamentals, as investor behavior generates self-fulfilling equilibria. The endogenous response of the distribution of returns is also shown to generate fluctuations in investment flows.
