Exchange Rate Volatility and FDI in the EMU Neighborhood Countries

Abstract

The purpose of this paper is to analyze the role of exchange rate volatility in explaining the evolution of FDI inflows in the EMU neighbourhood countries. Examining the question in the framework of an empirical model that considers the major macroeconomic determinants of FDI, the results of the paper suggest that the effect of exchange rate volatility on FDI crucially depends on a country’s degree of openness. In fact, while exchange rate volatility has positive or null effect for relatively closed economies, it has a negative impact on economies with a high level of openness. This result is particularly relevant for transition economies (Emerging Europe and CIS) and is robust to the use of different econometric specifications and measures of exchange rate volatility.