Exchange Rate Volatility's Impact on FDI

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Exchange Rate, Exchange Rate Volatility and Foreign Direct Investment
Article in World Economy · February 2004

DOI: 10.1111/j.1467-9701.2004.00664.x · Source: RePEc
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Exchange Rate, Exchange Rate Volatility and Foreign Direct Investment †
Kozo Kiyota Shujiro Urata

Yokohama National University Waseda University
May 2004
Abstract
In the light of the importance of foreign direct investment (FDI) for the promotion of economic
development, this paper examines the impact of the changes in the real exchange rate and its
volatility on FDI. Examining Japan’s FDI by industries, we found that the depreciation of the
currency of the host country attracted FDI, while the high volatility of the exchange rate discouraged
FDI. Our results suggest the need to avoid over-valuation of the exchange rate and to maintain
stable but flexible exchange rate in order to attract FDI.
JEL Classification Codes: F21 (International Investment; Long-Term Capital Movements), F23
(Multinational Firms; International Business); F33 (International Monetary Arrangements and
Institutions)
Key Words: Exchange Rate, Exchange Rate Volatility, Foreign Direct Investment
†We would like to thank Tuan Chyau, Takamune Fujii, Fukunari Kimura, Akira Kohsaka, Naoki Murano, Takanobu Nakajima, Linda F.
Y. Ng, Eiji Ogawa, Eric Ramstetter, and participants of a seminar at Keio University, annual meeting of Japanese Economic
Association, the 8th convention of East Asian Economic Association, the 1st international conference of Japan Economic Policy
Association, and anonymous referees for their helpful comments. Kozo Kiyota would like to thank the Nomura Foundation for
providing financial support for this project. However, all remaining errors are those of authors alone.
1. Introduction
The interest in the impacts of the exchange rate and its volatility on international capital flows such as
foreign direct investment (FDI) is growing among policy makers, as the number of countries adopting floating
exchange rate system has been increasing. Empirical investigation on the relationship between exchange rate and
FDI is very important for the formulation of FDI policies, because FDI brings various benefits to both investing
countries, or home countries, and recipient countries, or host countries. FDI transfers not only financial resources,
but also technology and managerial know-how from home countries to host countries. Financial resources are
largely used to expand productive capacity by increasing fixed investment in the host countries, while transfer of
technology and managerial know-how improves productive capability. Furthermore, FDI brings in various
networks such as sales and procurement networks to the host countries, which can be used to expand their business
opportunities. FDI also increases competitive pressures on local firms to result in an improvement in technical
and allocative efficiency in the host country. It is important to note that FDI also benefits the home country, and
investing firm, because it enables them to use their resources efficiently. In the light of important contributions
that FDI delivers to both home and host countries, it is useful to discern the factors that would promote FDI.
Several studies have empirically examined the effects of exchange rate on FDI (Froot and Stein, 1991;
Klein and Rosengren, 1994; Bayoumi and Lipworth, 1998; Goldberg and Klein, 1998; Ito, 2000; Sazanami and
Wong, 1997; Sazanami, Yoshimura and Kiyota, 2003). However, only few studies focused on the impacts of
exchange rate volatility. The findings from the previous studies on the impacts of exchange rate volatility on FDI
are mixed. Cushman (1985, 1988) and Goldberg and Kolstad (1995) find the positive impact of exchange rate
volatility on FDI while Urata and Kawai (2000) and Benassy-Quere, Fontagne and Lahreche (2001) find the
negative impact.
There are at least two reasons for the mixed results concerning the impacts of exchange rate volatility on
FDI. One possible reason is the aggregation problem. Most previous studies used aggregated national-level data
without industry breakdown. Recalling the findings by Froot and Stein (1991) and Sazanami, Yoshimura and
Kiyota (2003) suggesting different impacts of exchange rate on FDI among industries, the analysis of the
national-level data may result in the ambiguous results because such analysis masks impacts of exchange rate
volatility among industries by possibly offsetting the impacts across industries.
Another possible reason is the lack of adequate treatment of exchange rate volatility. Recent studies
suggest that movements of real exchange rate can be attributed to the failure of establishing the law of one price
(Engel, 1993, 1999; Rogers and Jenkins, 1995). They found that both the distance and the border played
important roles in such failure. These findings suggest the need to incorporate the distance and the border effects
in the analysis of exchange rate volatility.
This paper attempts to analyze the effects of exchange rate and its volatility on Japan’s FDI by extending
previous studies in several ways. First, rather than analyzing national-level FDI data without considering its
destination, we explicitly take into account of regional and sectoral differences in FDI. Second, we extend the
analytical framework adopted by Froot and Stein (1991) and Klein and Rosengren (1994) by incorporating the
impacts of the failures of law of one price between different markets on real exchange rate volatility as indicated by
Engel and Rogers (1996). We also examine the impacts of the US-dollar pegged system on FDI.
1
The structure of the paper is as follows. Section 2 briefly summarizes the previous empirical evidences
concerning the impacts of real exchange rate and its volatility on FDI. Section 3 presents the research design of
our analysis. Section 4 presents econometric results of the benchmark model, and section 5 extends the analysis
and examines the robustness of our results. In section 6 we conclude with a summary of the major findings and a
discussion of their policy implications.
2. A Brief Review of Previous Studies

2.1. Exchange Rate and Foreign Direct Investment
A number of empirical studies confirmed the strong impacts of exchange rate on FDI (Table 1). Froot and
Stein (1991) investigated the impact of real exchange rates on FDI from industrialized countries to the United
States by using annual data covering 1974-87 periods. Breaking overall FDI inflows into thirteen separate
industries, they found that all of the thirteen coefficients on the exchange rate presented negative signs, indicating
that the depreciation leads to greater FDI, and five of them were statistically significant (Froot and Stein, 1991,
Table 3). They also analyzed the FDI inflows of the United States, the United Kingdom, West Germany, Canada
and Japan, and found that the estimated coefficients of exchange rate were negative and statistically significant for
the cases in the United States and West Germany.
The similar relationship was confirmed by Klein and Rosengren (1994), Bayoumi and Lipworth (1998),
Goldberg and Klein (1998), Ito (2000), Sazanami and Wong (1997) and Sazanami, Yoshimura and Kiyota (2003).
Klein and Rosengren (1994) analyzed FDI from Canada, Japan, and several European countries to the United States
for the 1979-91 period, while Bayoumi and Lipworth (1998), Goldberg and Klein (1998), Ito (2000), Sazanami and
Wong (1997) and Sazanami, Yoshimura and Kiyota (2003) examined the impacts of exchange rate on Japan’s FDI
for different periods. 1 These studies revealed that the appreciation of the home currency vis-à-vis the host
currency encouraged FDI from the home country to the host country.
Most of these studies examined the relationship between exchange rates and national-level FDI with the
exceptions of Froot and Stein (1991) and Sazanami, Yoshimura and Kiyota (2003). Froot and Stein (1991)
focused on FDI to the United States between 1974 and 1987 and investigated the impacts of real exchange rate by
disaggregating national-level FDI into industry-level flows. 2 They found strong exchange rate impacts in
manufacturing industries, especially in chemicals, although the estimated coefficients for some industries were of
expected signs but statistically insignificant. Sazanami, Yoshimura and Kiyota (2003) examined Japan’s FDI at
industry level from 1978 to 1999. Focusing on four machinery industries, their study revealed that the real
exchange rates had stronger impacts on FDI in electronics and general machinery industries than in precision or
transportation industries. In sum, these two studies found that the depreciation of host currencies against home
currencies promoted FDI from home to host countries but the degree of the impacts were different across
industries.
1 Goldberg and Klein (1998) also conducted regression analysis that focuses on the United States.
2 The national-level FDI flows are disaggregated into thirteen industries: 1) all industries, 2) petroleum, 3) manufacturing -
subdisaggregated into 4) food, 5) chemicals, 6) fabricated metals, 7) machinery, 8) other manufacturing -, 9) trade, 10) finance, 11)
insurance, 12) real estate and 13) other industries.
2
2.2. Exchange Rate Volatility and Foreign Direct Investment
Compared with the studies analyzing the effects of exchange rate and other variables, there have been only
few studies that empirically examined the impacts of exchange rate volatility on FDI. Although the effects of the
exchange rate on FDI are generally robust in that the depreciation of host currency promotes FDI inflows to that
country, the impacts of exchange rate volatility on FDI have been shown ambiguous.
Cushman (1985, 1988) and Goldberg and Kolstad (1995) confirmed the positive impacts of exchange rate
volatility on FDI. Cushman (1985) investigated FDI from the United States to Canada, France, Germany, Japan
and the United Kingdom between 1963 and 1978 while Cushman (1988) analyzed FDI from Canada, France,
Germany, Japan and the United Kingdom to the United States between 1963 and 1986. Various measures of the
volatility 3 were used in his analyses and all estimated coefficients of the exchange rate volatility were positive.
Goldberg and Kolstad (1995) examined the impact of exchange rate volatility on bilateral FDI from Canada, Japan,
and the United Kingdom to the United States for the 1978-99 periods by using quarterly data. The exchange rate
volatility is measured by standard deviation of the real exchange rate over the 12 quarters, prior to and inclusive of
each period. They found the positive and statistically significant impact of exchange rate volatility on FDI.
Unlike the studies reviewed above, the negative impact of exchange rate volatility on FDI was confirmed by
Benassy-Quere, Fontagne and Lahreche (2001) and Urata and Kawai (2000). Benassy-Quere, Fontagne and
Lahreche (2001) investigated the impacts of exchange rate volatility, which was measured by the coefficient of
variation of quarterly nominal exchange rate over the past three years, on FDI from developed to developing
countries for the 1984-96 period by using annual data. They found that high exchange rate volatility discouraged
FDI while the depreciation of local currency promoted FDI from developed countries. Urata and Kawai (2000)
included exchange rates and their volatility, which was measured by the coefficient of variation of exchange rate
over five-year period, in their study of Japanese firms’ decision on the location of their FDI. By analyzing a
firm-level panel data covering 1980-94 for 117 countries from four manufacturing industries 4 in Japan, they found
that high exchange rate volatility discouraged FDI while the depreciation of host country currency increased
Japanese FDI to the depreciating country.
2.3. Sources of Real Exchange Rate Movements

In analyzing the impacts of real exchange rate volatility on FDI, one should be concerned with the sources
of real exchange rate movements. Recent empirical studies suggest that the behavior of real exchange rate is
attributed to the failures of establishing the law of one price (Engel, 1993, 1999; Rogers and Jenkins, 1995).
Indeed, these studies found that the distance and the border played important roles in the failures of establishing the
law of one price, which in turn becomes part of the source of real exchange rate movements (Engel and Rogers,
1996).
Engel and Rogers (1996) tested two hypotheses: 1) the volatility of the prices of similar goods between
cities should be positively related to the distance between those cities because of the geographical separation of the
markets in determining the degree of the failures of law of one price and 2) the volatility should be higher between
3 For the definition of short-run and long-run measures, see Table 1.
3
two cities separated by the national border holding the distance constant. Using the price data of the United States
and Canada, their regression analysis confirmed the validity of these two hypotheses: both the distance and the
national border were important in explaining the price dispersion between cities when exchange rate is flexible.
Engel (1993, 1999) and Rogers and Jenkins (1995) analyzed the behavior of goods prices across and within
countries. Based on the detailed econometric analysis with disaggregated price data, they found that the
movements of prices of similar goods across borders accounted for much of the movements in real exchange rate.
These studies suggest that the failures of the law of one price, partly explained by the distance and the border, have
large impacts on the behavior of real exchange rates.
2.4. Extension of Previous Studies

The previous studies revealed that the depreciation of host currency relative to home currency promoted
FDI to the depreciating country, while the impacts of exchange rate volatility on FDI were ambiguous. One
extension of the previous analyses is to focus on industry-level FDI rather than country-level FDI as Froot and
Stein (1991) and Sazanami, Yoshimura and Kiyota (2003). If the impacts of real exchange rates on FDI are
different across industries, the impacts may offset one another in the analyses based on aggregated data.
Another extension is to incorporate the impacts that may arise from the failures of the law of one price on
real exchange rate volatility. As Engel and Rogers (1996) suggested, a part of the exchange rate volatility arises
from the failures of establishing the law of one price, which is explained by the distance and the national border
between markets. Since the distance and the national border between markets are known information for investors,
the exchange rate volatility, which is explained by these factors, should not be treated as ‘volatile’ for investors in
making FDI decisions. In order to focus on the uncertain and unexplained part of the exchange rate volatility,
therefore, the impacts of the failures of the law of one price should be excluded from the ‘true’ exchange rate
volatility.
3. Research Design
3.1. The Benchmark Model
This paper follows a model used in Froot and Stein (1991) and Klein and Rosengren (1994) with some
modifications for investigating the impacts of exchange rate volatility on FDI. Specifically, the regression
equation includes exchange rate volatility and exchange rate as the explanatory variables.
The depreciation of the currency of the host country is expected to attract FDI inflows at least for the
following two reasons. First, the currency depreciation reduces production costs in the host country vis-à-vis
other countries including the home country, thereby making it attractive for FDI seeking for production efficiency.
Second, the currency depreciation lowers the value of assets in the depreciating host country in terms of other
currencies including the currency of the home country. Accordingly, the cost of undertaking FDI declines in terms
of foreign currency, making FDI in the depreciating country attractive.
The exchange rate volatility has two aspects: flexibility and uncertainty. Although the flexible exchange
4 Four manufacturing industries are 1) textiles, 2) general machinery, 3) electric machinery and 4) transportation machinery.
4
rate is one of the most important factors for promoting international financial flows, high exchange rate volatility
would discourage FDI because it would be regarded as increased uncertainty or increased risk rather than flexibility
of exchange rate for potential investors. FDI is not the portfolio-type investment and it incurs large sunk costs.
Given such characteristics of FDI, investors are likely to be risk-averse, implying that they prefer low exchange rate
volatility to high volatility if their expected profits are equivalent between low and high volatility.
Our regression analysis uses annual FDI from Japan to its partner countries between 1990 and 2000. Since
the FDI data used in the analysis are bilateral flows between countries rather than between cities, part of the border
effects should be taken into account but the distance effects remain intact.
Real exchange rate volatility is assumed to consist of two parts: one is a part explained by the failures of
establishing the law of one price and the other is an unexplained part. In order to focus on the unexplained part of
the real exchange rate volatility, we define unexplained part of volatility, VOLit , as the deviation of the actual
value from the value explained by the failure of the law of one price:
 ei P   ei P 
(1) VOLit = var t i t  − var̂ t i t  ,
 P   P 
 t   t 
(
where var eti Pt Pt i ) is the actual volatility and ( )
var̂ eti Pt Pt i is the volatility explained by the failures of law
of one price. The real exchange rate, eti Pt Pt i , represents the ratio of the price in Japan in year t , Pt , to the
price in country i in that year, Pt i , and the nominal exchange rate in that year, eti , which is defined as the
amount of foreign currency of country i required to purchase one Japanese Yen. The real exchange rate
( )
volatility, var eti Pt Pt i , is the variance of the changes in the real exchange rate. The large magnitude of VOLit
means that the factors other than the failures of the law of one price play an important role in the real exchange rate
volatility.
According to Engel and Rogers (1996), the distance and the national border can explain a part of real
exchange rate volatility. To take into account of the distance and the border effects on exchange rate volatility, we
estimate the gravity equation of the form:
 ei P 
(2) var t i t  = α 0 + α 1 ln Dist i + α 2 ln GDPt i GDPt j + µ ti ,
 P 
 t 
where superscripts i and j refer to the host and home countries, respectively. Subscript t refers to the time
5
i
period. The right-hand side variables are the distance from home country to country i , Dist , and the error
term, µ ti . 5 Since we examine the host countries of different economic size, we include GDP of the home and
host countries, GDPt i and GDPt j , respectively to control for the market size of the countries involved.
Country-level analysis used here can partly control for the border effects. To control for other country-specific
random effects and macro economic shocks, we use the random-effect model with the year dummies for the
estimation. Fitted values obtained from this equation indicate the explained parts of the real exchange rate
(
volatility and, they are denoted as var̂ eti Pt Pt i . )
To examine the effect of exchange rate and its volatility on FDI, we use similar specification adopted by
Froot and Stein (1991) and Klein and Rosengren (1994):
FDI ti eti Pt
(3) ln i
= β 1 ln i
+ β 2VOLit + β 3Trend ti + ε ti ,
GDPt Pt
where the left-hand side variable is FDI from Japan to country i , FDI ti , as a proportion to country i’s GDP,
GDPt i , in year t . As for the right-hand side variables, real exchange rate, eti Pt Pt i , the unexplained part of
the exchange rate volatility, VOLit , and time trend, Trend ti , are included. Real exchange rate volatility is
obtained from the obtained results of equations (1) and (2). The definitions and the data sources for the variables
used in the regression are summarized in the data appendix. According to the hypotheses presented above, we
expect β 1 > 0 and β 2 < 0 for the exchange rate and its volatility, respectively.
3.2. Description of the Data

Before undertaking a statistical analysis of the impacts of exchange rate volatility on Japan’s FDI, this
section briefly examines the patterns of Japan’s FDI from 1990 to 2000. The FDI data employed in this paper are
taken from Ministry of Finance, Government of Japan (2002). Table 2 presents FDI by industry while Table 3
shows FDI by destinations. The definitions of regional destinations are summarized in Appendix Table.
=== Table 2 and Table 3 ===
An examination of the sectoral patterns of Japanese FDI in Table 2 shows that the share of
non-manufacturing fluctuated around 60-70 percent, while the share of manufacturing fluctuated around 30-40
percent. Among manufacturing sub-sectors, electric machinery and transport equipment had large shares,
5 When we focus on the host currency/yen exchange rate and its volatility, we regard Japan as a home country. On the other hand,
6
indicating around 10% throughout the period. As to non-manufacturing sub-sectors, large shares are found in
finance, insurance and real estate industry, indicating 28.8% on average from 1990 to 2000, though the share
declined to around 18% from 1999. An examination of the regional destinations in Table 3 indicates that East
Asia and Pacific, EU-15 and North America are three major destinations. In 2000, these three regions accounted
for 88.8 percent of Japan’s FDI. Japan’s FDI to emerging market economies in Europe and Central Asia, Latin
America also grew in the mid-1990s but it has been stagnant in recent years.
We computed the basic statistics and the correlations of the variables used in the analysis, which are
summarized in Tables 4 and 5. Table 5 observes the strong correlations between Japanese and the U.S. real
exchange rate volatilities, indicating the possibility of the problem arisen from multicollinearity in the estimation if
we include Japanese and the U.S. real exchange rates jointly. To avoid the problem of multicollinearity, we
estimate the impacts of real exchange rate of host currency/yen and host currency/dollar separately.
=== Table 4 and Table 5 ===
3.3. Econometric Issues: Heterogeneity and Nonstationarity

A recent study by Baltagi (2001) noted two potential problems concerning macro panel study. One is the
heterogeneity of the regression parameters across countries and the other is the nonstationarity of the panels. To
deal with these two issues, we conduct a panel-based unit root test proposed by Im, Pesaran and Shin (2002) (IPS),
which can be applied when the panel data are heterogeneous. Their test statistic is constructed by averaging the
statistics from the augmented Dickey-Fuller (ADF) tests with the following equation:
pi
(4) y = γ t Trend + ρ i y
i
t t
i i
t −1 + ∑ ϕ ij ∆y ti− j + ε ti ,
j =1
where y ti is a variable under consideration, ∆y ti− s = y ti − y si and p

i
is a lag. The null hypothesis is that all
series in the panel contain a unit root ( ρ i = 1 ) while the alternative hypothesis is that at least one of the series in
the panel is stationary ( ρ i < 1 for at least one country). The IPS t-bar test static is constructed by averaging
ADF t-static as:
N
1
(5) t =
N
∑tρ ,
i =1
i
where t ρi is the ADF t-statistic for country i and N represents the number of countries. Although other panel
unit root tests have been proposed (Levin, Lin and Chu, 2002), the IPS method imposes fewer restrictions in the
the United States is regarded as the home country when we use the host currency/dollar rate and its volatility.
7
sense that it allows ρ to be heterogeneous across countries. 6 Wu (1996) also argues that panel-based test yields
higher power than standard unit root tests based on individual time series. We therefore conduct IPS tests to
examine the nonstationarity of the panels.
Table 6 presents the results of unit root tests. The figures indicate the value of t-bar. The test results
show that most variables, except relative wages, reject the null hypothesis that the series contain unit roots. The
7
results are fairy robust even when the equation includes time trends or when we change lag-orders. Our results,
which are also consistent with those of Wu (1996), indicate the absence of nonstationarity problem for the variables
used in the analysis.
=== Table 6 ===
4. The Estimation Results

Table 7 presents the estimation results of equation (3). We employ the feasible generalized least squares
(FGLS) estimation method with heteroskedastic error term. 8 As for all industry and manufacturing total results,
all the coefficients of host currency/yen real exchange rate and real exchange rate volatility show expected signs
with statistical significance. 9 The estimated coefficients of host currency/dollar real exchange rate and its
volatility also present expected signs with statistical significance except the coefficient of the exchange rate in the
case of all industry. One interesting finding is the difference of the coefficients between those on host
currency/yen and on host currency/dollar: the coefficients of host currency/yen show larger figures than those of
host currency/dollar in both exchange rate and its volatility. These results, which need to be investigated in detail,
may reflect the behavior of Japanese firms that put a greater importance to the value of the yen than the dollar in
making FDI decisions. As will be shown later, the importance of the dollar for Japanese firms’ decision on FDI
location differs substantially depending on the location of their FDI.
=== Table 7 ===
The regression results of industry-level FDI generally present similar patterns in that both host currency/yen
and host currency/dollar real exchange rates play an important role for the determination of FDI location by
Japanese firms. High volatilities in host currency vis-à-vis the yen as well as the dollar discourage Japan’s FDI.
One notes some different findings from the industry-level investigation, when compared to the results from
the analyses of all industry or manufacturing total. Unlike the case for all industry or manufacturing total, the
coefficients of the host currency/yen real exchange rate and its volatility are smaller than those of host
currency/dollar real exchange rate and its volatility in chemical products and transport equipment. Moreover, the
6 See, for more detail, Baltagi (2001).

7 The choice of lag order is an issue. However, since our time period only covers 10 years, we just test from 1-year to 3-year lags.
As for the choice of lag order, see Campbell and Perron (1991).
8 This means that the variance for each country is assumed to differ. As for FGLS, see, for instance, Baltagi (2001).
9 For the results shown in Table 7 exchange rate volatility was computed by considering exchange rates for the preceding 3-year
period. We also used the value based on 1-year and 2-year periods, and found that the results were basically the same.
8
magnitude of the coefficients varies across manufacturing subsectors. These results imply that the currencies
mainly used by multinational enterprises for making FDI decisions are different across industries.
Our investigation reveals that the overvaluation of the host currency/yen and the host currency/dollar real
exchange rates discourage Japan’s FDI. In addition, volatilities in both the host currency/yen and the host
currency/dollar real exchange rate have strong negative impacts on FDI. These results imply that the need to
avoid overvaluation of the exchange rate and to maintain stable exchange rate in order to attract FDI.
5. Some Extensions
5.1. Regional Difference
One possible criticism of our analysis in the previous section is dismissal of the differences in the
importance of the currency for foreign firms in making FDI decisions in different parts of the world. For instance,
Japanese yen plays an important role for foreign firms’ decision on FDI in East Asia, as Japanese yen is used
relatively extensively in various types of transactions including goods and services compared to the case in Latin
America. Under such circumstances, host currency/yen real exchange rate is expected to have a significant
influence on FDI in East Asia but not in Latin America. In order to examine the regional differences in the
importance of different currencies, namely the U.S. dollar and Japanese yen, this section compares the determinants
of FDI to East Asia and to Latin America.
Table 8 presents the estimated results for Japan’s FDI to East Asia and to Latin America. The upper
portion presents the results for the case of East Asian countries while the lower portion shows those for Latin
American countries. Two notable observations are obtained in these tables. First, the real exchange rate of host
currency vis-à-vis Japanese yen and its volatility have important impacts on Japan’s FDI in both regions.
Specifically, as to the case of East Asia, all the coefficients on the host currency/yen real exchange rate are found to
be of expected signs and statistically significant. Ten out of eleven cases show expected and statistically
significant signs for exchange rate volatility. In Latin America, ten out of eleven industries are expected signs
with statistical significance for exchange rate and all the coefficients present expected negative significant signs for
exchange rate volatility. These results imply that the exchange rate between host currency and yen is a very
important determinant for Japanese firms in investing in Latin America as well as East Asia.
=== Table 8 ===
Second, a comparison of the results for East Asia and those for Latin America reveals that real host
currency/dollar exchange rate and its volatility are more important for Japanese firms in Latin America than in East
Asia. For Japan’s FDI in Latin America, the coefficients of host currency/dollar exchange rate present expected
significant signs in six out of eleven industries while only one expected significant coefficient of host
currency/dollar exchange rate is obtained for the case of Japan’s FDI in East Asia. As to the exchange rate
volatility, all industries show expected negative signs with statistical significance for the case of Latin America
while seven out of eleven cases present expected significant signs for East Asia. It is interesting to note that the
9
coefficients of host currency/yen as well as host currency/dollar volatilities in Latin America tend to be larger than
those in East Asia, implying that the high exchange rate volatility in Latin America is of great concern for Japanese
firms in their decisions on FDI.
5.2. Alternative Definitions of Volatility

Another possible criticism concerns the definition of unexplained part of volatility since our results might
depend on the specification of the explained part of volatility. To investigate the robustness of our results, we
estimate the equations by adopting the following two types of specifications. One is the specification, which does
not take into account of border effects or distance effects in defining real exchange rate volatility:
FDI ti eti Pt  eti Pt 

β β  
= +  P i  + β 3Trend t + ε t .
i i
(6) ln 1 ln 2 var
GDPt i Pt i  t 
( )
In this case, we use actual volatility, var eti Pt Pt i , instead of unexplained volatility, VOLit .
The other specification adopts a different definition for the explained volatility:
 ei P 
(7) var t i t  = α 0 + α 1 ln Dist i + µ ti .
 P 
 t 
We drop GDP from the equation (2) to investigate the sensitivity of the results and re-calculate VOLit based on
equation (1). The estimation method is the same as that used in Section 4.
Table 9 presents the estimated results. The upper part indicates the results using actual exchange volatility
while the lower part shows the results by controlling for the distance in determining the exchange rate volatility.
For the case where actual volatility is used, the results generally indicate expected signs but the significance levels
of the coefficients are low compared with the results in Table 7. When we control for the distance, the results
slightly improve when compared with those without such control. The coefficients of the host currency/yen real
exchange rate, its volatility and host currency/dollar exchange rate present significantly expected signs. However,
the coefficients of host currency/dollar exchange rate do not show expected signs. The results show unexpected
but significant signs in the following cases: all industry, manufacturing total, food industry, primary metals and
metal products, transport equipment and services.
According to the results obtained from the analysis using alternative definitions of exchange rate volatility,
the exchange rate volatility generally has a negative impact on Japan’s FDI and, therefore, our results can be
considered quite robust. However, as the Akaike’s Information Criteria (AIC) indicates, benchmark results are
more reliable than those obtained from alternative specifications used for exchange rate volatility.
10
5.3. Is the U.S. Dollar Peg System An Attractive Exchange Rate Regime for Foreign Investors?
The recent studies on the exchange rate system stress a risk of pegging to a single currency. Sazanami and
Yoshimura (1999) suggested that the stable movements of exchange rate between East Asian currencies and the U.S.
dollar from 1995 to 1997 could be considered as the evidence of a de facto U.S. dollar peg system in East Asian
countries. Though they recognized several merits of the U.S. dollar peg system such as the removal of exchange
rate risks for foreign investors, the depreciation of the yen against the dollar from the mid-1995 adversely affected
East Asian exports to Japan.
Ito, Ogawa and Sasaki (1998) analyzed the exchange rates of the currencies for East Asian countries and
computed the optimal weights of the foreign currencies such as U.S. dollar and Japanese yen for East Asian
currencies to maintain their competitiveness by taking into account of the importance of different countries in
international trade of East Asian countries. Their motivation was their recognition of the fact that one common
factor for the crisis-hit East Asian countries was the choice of a de facto dollar peg system. Estimating the actual
and optimal weights of the currencies for East Asian countries, they found that the optimal weight of the U.S. dollar
was much lower than actual weight.
Is the U.S. dollar peg system an attractive exchange rate regime for foreign investors? To answer this
question, we include the U.S. dollar peg dummy in the regression equation:
FDI ti eti Pt
(8) ln i
= β 1 ln i
+ β 2VOLit + β 3Trend ti + β 4USPeg ti + ε ti ,
GDPt Pt
The U.S. dollar peg dummy, USPeg ti , takes the value of unity if the nominal exchange rate (host currency/dollar)
volatility is zero and takes zero otherwise.

Table 10 presents the estimation results of equation (8), which includes the U.S. dollar peg dummy. The
impacts of the U.S. dollar peg system on FDI flows are not consistent and vary among the industries. Negative
impacts are observed in all industry, manufacturing total, chemical industry, electric machinery, transportation
equipment and wholesale and retail trade industries. As for the estimation results for the variables other than the
dollar peg dummy, we obtain similar results to those without the U.S. dollar peg dummy in Table 7. These results
appear to indicate that the U.S. dollar peg system is not always effective in attracting FDI from Japan.
=== Table 10 ===
This finding indicates that the U.S. dollar peg system has some impacts on FDI but it is not always
attractive system for potential investors. As we discussed in Section 3, the exchange rate volatility has two
aspects: flexibility and uncertainty. The U.S. dollar peg system may reduce uncertainty, creating a favorable FDI
environment, but it may lead to overvaluation of the host currencies, reducing the attractiveness of the host
countries to foreign investors. Furthermore, fixed exchange rate under the U.S. dollar peg system will be very
11
risky if there are speculative attacks. Some investors may prefer a flexible but not highly volatile exchange rate
system to a fixed exchange rate system.
5.4. Additional Control Variables

As presented in Table 1, previous studies revealed that not only the real exchange rate but also the relative
labor costs and the agglomeration effects were important factors for determining FDI flows. If we miss the
important factors in the regression analysis, the omitted variable biases emerge in the estimated coefficients as a
standard econometric textbook suggests. In this section, we incorporate the effects of the relative labor costs and
the agglomeration in the regression as additional control variables:
FDI ti eti Pt wt CUMFDI ti−1

(9) ln i
= β 1 ln i
+ β 2VOLi
t + β 3 Trend t
i
+ β 4 ln i
+ β 5 ln i
+ ε ti ,
GDPt Pt wt GDPt −1
where wt wti is the relative labor costs (the ratio of wage rate in Japan, wt , to wage rate in country i , wti ) and
CUMFDI ti−1 is the cumulative FDI from Japan to country i with one-year lag. The cumulative FDI is the
stock of FDI and measured by the sum of the left-hand side FDI from 1989 to year t − 1 . In the case of FDI at
national-level, the cumulative FDI is the sum of national-level FDI, while in the case of FDI at industry-level, the
cumulative FDI is the sum of industry-level FDI under study. We expect β 4 > 0 and β 5 > 0 . We expect
relative wages, wt wti , to have a positive impact on FDI, because low cost of production would attract FDI. We
also expect a positive effect from cumulative FDI, CUMFDI ti−1 , for several reasons. A potential investor may
regard the host country with substantial amount of FDI stock as a safe place for its investment. Since FDI incurs
substantial sunk cost, security consideration is very important. At industry level, FDI stock partly captures the
agglomeration effects. 10 A potential investor may find ample business opportunities in a potential host country
with a huge FDI stock.
Estimated results of equation (9) are presented in Table 11. Although the coefficients of the host
currency/yen and the host currency/dollar exchange rate sometimes present unexpected signs, all the coefficients of
exchange rate volatilities indicate expected signs. Statistically significant signs are confirmed in seven out of
eleven industries for the host currency/yen and in nine out of eleven industries for the host currency/dollar
exchange rate volatilities. The results indicate that higher the exchange rate volatility, the less attractive country
for Japanese firms to locate even when we control for other factors.
=== Table 11 ===
10 For the importance of the agglomeration effects on FDI, see for instance, Head, Ries and Swenson (1995).
12
As to relative labor costs, 19 out of 22 cases show expected signs with statistical significance. Statistically
significant expected signs are confirmed in all the coefficients on cumulative FDI. We also run the regression
without relative the labor cost variable but we find the results are not largely affected by the wage variable. These
results imply that both the relative labor costs and the agglomeration effects are important factors for the Japan’s
FDI after controlling for the exchange rate and its volatility.
6. Concluding Remarks
We examined the impacts of the exchange rate and its volatility on Japan’s FDI at aggregated as well as
disaggregated industry levels. The results generally indicate that the depreciation of the host country currency
attracts FDI while large volatility in real exchange rates discourages FDI. As one would expect, we found that
host currency/yen exchange rate volatility had much larger impacts on Japanese investors than host currency/dollar
exchange rate volatility.
Somewhat in contrast to a common view, our results do not always indicate that the U.S. dollar peg system
was an attractive exchange rate regime for foreign investors. For some industries, the U.S. dollar peg system has
negative impacts on FDI. These results suggest that the exchange rate regimes should be flexible but not highly
volatile for attracting FDI from Japan.
We also found the regional differences in the impacts of exchange rate volatility on FDI for East Asia and
for Latin America. For FDI in East Asia the volatility in the host currency/yen exchange rate has a substantial
impact whereas for FDI in Latin America the volatility in the host currency/dollar exchange rate also has important
impacts. In addition, high exchange rate volatility in Latin America is of great concern for Japanese firms in their
decisions on FDI. These findings appear to reflect the importance of the yen in East Asia on the one hand and the
U.S. dollar in Latin America on the other hand, in business transactions in these two regions. The impacts of
exchange rate and its volatility were found to be different across industries but any discernable patterns were not
confirmed.
Our findings have important policy implications. Overvaluation of the currency, which often results from
inappropriate macroeconomic policies, discourages FDI, and therefore the government should pursue sound
macroeconomic policies. The same policy implications may be obtained from the result indicating the negative
impact of exchange rate volatility on FDI. Flexible but stable exchange rate system is needed to successfully
attract FDI.
We hope that our analysis contributes to the discussion on the appropriate exchange rate system, but at the
same time we realize the need for further research on this subject. For instance, the industry-level analysis has
some limitations, when foreign firms even in the same industry have different FDI objectives. Suppose two types
of foreign firms with two different FDI objectives are found in the same industry. One type of foreign firms is
interested in low cost production and therefore undertakes FDI in low-wage host countries. The other type of
foreign firms is interested in local sales and undertakes FDI in high-income (high-wage) countries. Under such
circumstances, industry-level analysis cannot capture the impact of exchange rate changes, which are reflected in
the changes in relative wages, on FDI. This observation indicates the need to undertake firm-level analyses,
13
which requires detailed information on firm activities, in order to discern the impact of exchange rate changes on
FDI.
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Data Appendix
This appendix explains about the definitions and data sources of variables.
15
Real exchange rate and real exchange rate volatility
The real exchange rate, eti Pt Pt i , is normalized assuming a value in 1995 of 100. Nominal exchange
rate, eti , is defined as the amount of foreign currency of country i required to purchase one Japanese Yen (or one
U.S. dollar). The relative price of Japan to country i , Pt Pt i , is the relative CPI index of Japan to country i .
CPI is taken from IMF (2002). As for Taiwan, CPI data are taken from Central Bank of China (various months).
We use CPI rather than wholesale or producer price index since FDI direct into non-tradable as well as tradable
sectors even when the parent company belongs to tradable goods sector. Exchange rates of the yen against the
host currencies are obtained by applying the yen/dollar rates.
( )
Real exchange rate volatility, var eti Pt Pt i , is measured by the variance of percentage changes in the real
exchange rate for the period preceding three years by using monthly data.
Foreign Direct Investment
Japan’s outward FDI, FDI ti , are from Japanese Ministry of Finance (2002). Japanese data are converted
from Japanese yen to U.S. dollars by the annual average nominal exchange rate that is obtained from IMF (2002)
line [rf]. In our analysis, we follow Bayoumi and Lipworth (1998) in obtaining real FDI by deflating nominal FDI
value by the host country’s GDP deflator. The source of GDP deflators is the World Bank (2002). Taiwan’s data
are taken from the Council for Economic Planning and Development, Republic of China (2001). GDP deflator is
computed from the GDP current prices (U.S. dollar) divided by the GDP 1995 prices (U.S. dollar).
Countries whose data entry equals to zero are excluded from our samples. Zero pairs of bilateral FDI
present a problem for econometric estimation of equations used in our analysis because one cannot take the natural
log of zero. For the treatment of zero value in analyzing the FDI, more discussion seems to be needed. 11 The
cumulative FDI, CUMFDI ti−1 , is computed by summing annual real FDI, starting from 1989 to t − 1 for Japan.
GDP and relative labor costs
GDP, GDPt i , is defined as GDP in 1995 constant prices (U.S. dollars) and is from World Bank (2002).
Relative labor cost, wt wti , is the ratio of GDP per capita of the to that of host country. We used per capita GDP
as a proxy for average wage. Although we realize that the ILO wage index in ILO (2002) would be more
desirable for our analysis than per capita GDP, the limited availability of data for the countries under study
11 Frankel (1997, p.145) presens excellent summary of the problems and the remedies of zero value entries for gravity model.
16
precludes us from using the ILO index. 12
Distance
Distance data are mainly from the Haveman (2002). The data are the distance of capitals between two
countries and measured by kilometers. Countries that are not covered by Haveman (2002) are filled using
Fitzpatrick and Modlin (1986). For countries whose data are not available in these two sources, we regard the
nearest large city as a proxy of capital: Isle of Man (Belfast), Kazakhstan (Karaganda) and Macao (Hong Kong),
Slovak Republic (Kosice) and Slovenia (Zagreb).
12 The correlation of the natural log of relative wage, (

ln wt wti ), between ILO wage index (labor compensation per unit of output
from ILO (2002)) and the per capita GDP is 0.82. The number of available countries is at most 26 for ILO wage index while at least
110 countries are available for per capita GDP from 1989 to 2000. ILO wage index is not available after 1999 for Japan.
17
Table 1 Major Regression Results of the Previous Empirical Studies
Froot and Stein (1991) Klein and Rosengren (1994) Bayoumi and Lipworth (1998) Goldberg and Klein (1998) Sazanami, Yoshimura and Sazanami and Wong (1997) Ito (2000)
Kiyota (2003)
Period 1974-1987 1979-1991 1982-1995 1978-1994 1978-1999 1977-1992 1976-1996
type Annual/quarterly Annual Annual Annual Annual Annual Annual
Industry 13 industries All industry All industry All industry 8 industries All industry All industry
Dependent Variable
Real inward FDI flows Real inward FDI flows Growth of real outward FDI Real outward FDI flows Real outward FDI flows Nominal outward FDI flows Nominal outward FDI flows
FDI flows
FDI flows from Austria, FDI flows from Canada, FDI frows from Japan to 20 FDI flows from Japan to FDI flows from Japan to FDI flows from Japan to Asia, FDI flows from Japan to
Australia, Belgium, Canada, France, Germany, Japan, major trading partners. (natural Argentina, Brazil, Chile, China, Hong Kong, Indonesia, the EC and United States. Korea, Taiwan, Hong Kong,
Denmark, France, West Netherlands, Switzerland and log) Indonesia, Malaysia, Thailand Korea, Malaysia, Singapore, Singapore, Indonesia,
Germany, Italy, Japan, the U.K. to the U.S. divided by and the Philippines. (natural Taiwan, the Philippines and Thailand, Malaysia, the
Netherlands, Norway, Spain, the U.S. GDP. (natural log) log) Thailand. (natural log) Philippines.
Sweden, Switzerland and the
U.K. to the U.S. divided by the
U.S. GDP.
Independent Variables
Exchange Rate
Level negative negative negative negative negative negative negative
1/RER(US$/home): Index of RER(home/host) RER(yen/host): GDP deflator RER(yen/host): PPI/WPI/CPI RER(yen/host): WPI base Index of NER(yen/US$) NER(yen/US$) (lagged 1 year)
IMF merm real value of the base base
dollar.
Volatility --- --- --- --- --- --- ---
--- --- --- --- --- --- ---
Other Variables
Demand
Level --- --- --- positive --- positive ---
Growth --- --- --- --- --- --- positive
Distance --- --- --- --- --- --- ---
Openness --- --- --- --- --- --- ---
Relative labor cost --- negative --- --- positive positive ---
Relative wealth --- negative --- --- --- --- ---
Cummlative FDI --- --- negative --- positive --- ---
Trend positive positive --- --- negative --- negative
Notes: 1) Major results are reported. "---" indicates that variables are not included in the analysis.
2) RER: real exchange rate; NER: nominal exchange rate; host: the currency of recipient country; home: the currency of investing country
Table 1 (continued) Major Regression Results of the Previous Empirical Studies
Cushman (1985) Cushman (1988) Goldberg and Kolstad (1995) Benassy, Fontagne and Urata and Kawai (2000)
Lahreche (2001)
Period 1963-1978 1963-1986 1978:1-1991:4 1984-1996 1980-1994
type Annual Annual Quarterly Annual Annual
Industry All industry All industry All industry All industry 4 manufacturing industries
Dependent Variable
Real FDI outflows Real inward FDI flows Real outward FDI flows Real inward FDI stocks Location choice of Japanese
FDI firms
Annual bilateral FDI flows Annual bilateral FDI flows into Bilateral FDI flows between FDI stock data for 42 117 countries chosen by
from the U.S. to the U.K., the U.S. from the U.K., France, Canada, Japan, the U.K. and developing countries from 17 Japanese firms.
France, Germany, Canada and Germany, Canada and Japan. the U.S. OECD countries.
Japan.
Independent Variables
Exchange Rate
Level negative negative negative positive positive
RER(host/home): WPI RER(home/host): WPI base RER(home/host): CPI base RER(host/home): CPI base NER(host/yen)
Volatility positive positive positive negative negative

The standard deviation of Short-run measure, which is S.D. of RER over rolling The coefficient of variation of The coefficient of variation on
observed quarterly valuses of the mean of the four quaterly samples of 12 quarters of data, quarterly NER over the past 3 exchange rate (5 years
the changes of RER within the values within the year of a prior to and inclusive of each years. average).
year; The average level of moving four-quarter s.d. of period t, normalized by the
"surprise" during the year RER; Long-run measure, mean level of the exchange rate
where surprise is the deviation which is a moving three-year within the interval.
of the currently observed the s.d. of recent annual changes in
changes in RER from what was RER.
expected last quarter.
Other Variables
Demand
Level positive positive positive --- positive
Growth --- --- positive --- ---
Distance --- --- --- negative ---
Openness --- --- --- positive ---
Relative labor cost --- --- --- --- positive
Relative wealth --- --- --- --- ---
Cummlative FDI --- --- --- --- positive
Trend --- --- --- --- ---
Table 2 Trends of Japan's Foreign Direct Investment, by Industry
Value (US$ million) 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 1990-2000
All industry 57,688 42,211 34,988 37,333 41,883 52,699 49,728 54,739 39,852 65,308 49,821 526,251
Manufacturing total 15,690 12,560 10,294 11,480 14,114 19,387 20,979 19,614 11,983 41,431 11,981 189,513
Food 837 647 529 875 1,305 862 755 580 1,242 14,598 264 22,495
Chemical products 2,323 1,635 2,040 1,837 2,657 2,211 2,133 3,056 2,197 1,659 1,965 23,711
Primary metals and metal products 1,058 919 847 796 1,048 1,593 2,533 1,433 1,196 1,428 725 13,576
General machinery 1,476 1,301 1,128 1,226 1,660 1,924 1,489 1,302 778 974 1,447 14,705
Electric machinery 5,773 2,336 1,861 2,817 2,675 5,518 6,745 6,784 3,343 16,011 3,125 56,988
Transport equipment 1,893 2,014 1,230 987 2,090 2,062 4,011 2,949 1,572 4,681 3,218 26,708
Other manufacturing 2,331 3,707 2,659 2,942 2,679 5,218 3,313 3,509 1,654 2,080 1,238 31,331
Non-manufacturing total 41,192 29,180 24,326 25,584 27,374 32,314 27,693 34,542 27,520 23,675 37,584 330,985
Finance, insurance and real estate 19,347 14,068 9,979 12,878 12,000 11,785 14,484 17,751 18,762 11,749 8,994 151,797
Trade 6,240 5,308 3,780 5,336 4,481 5,474 4,952 4,437 3,694 3,796 3,429 50,927
Services 11,545 5,471 6,739 3,695 7,026 11,003 4,190 6,571 2,008 4,224 1,805 64,277
Other non-manufacturing 4,061 4,333 3,829 3,676 3,868 4,052 4,067 5,783 3,056 3,906 23,355 63,985
Not classified 806 472 367 269 395 997 1,056 582 349 201 257 5,752
Share (All industry = 100.0%) 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 1990-2000
All industry 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Manufacturing total 27.2 29.8 29.4 30.8 33.7 36.8 42.2 35.8 30.1 63.4 24.0 36.0
Food 1.5 1.5 1.5 2.3 3.1 1.6 1.5 1.1 3.1 22.4 0.5 4.3
Chemical products 4.0 3.9 5.8 4.9 6.3 4.2 4.3 5.6 5.5 2.5 3.9 4.5
Primary metals and metal products 1.8 2.2 2.4 2.1 2.5 3.0 5.1 2.6 3.0 2.2 1.5 2.6
General machinery 2.6 3.1 3.2 3.3 4.0 3.7 3.0 2.4 2.0 1.5 2.9 2.8
Electric machinery 10.0 5.5 5.3 7.5 6.4 10.5 13.6 12.4 8.4 24.5 6.3 10.8
Transport equipment 3.3 4.8 3.5 2.6 5.0 3.9 8.1 5.4 3.9 7.2 6.5 5.1
Other manufacturing 4.0 8.8 7.6 7.9 6.4 9.9 6.7 6.4 4.2 3.2 2.5 6.0
Non-manufacturing total 71.4 69.1 69.5 68.5 65.4 61.3 55.7 63.1 69.1 36.3 75.4 62.9
Finance, insurance and real estate 33.5 33.3 28.5 34.5 28.6 22.4 29.1 32.4 47.1 18.0 18.1 28.8
Trade 10.8 12.6 10.8 14.3 10.7 10.4 10.0 8.1 9.3 5.8 6.9 9.7
Services 20.0 13.0 19.3 9.9 16.8 20.9 8.4 12.0 5.0 6.5 3.6 12.2
Other non-manufacturing 7.0 10.3 10.9 9.8 9.2 7.7 8.2 10.6 7.7 6.0 46.9 12.2
Not classified 1.4 1.1 1.0 0.7 0.9 1.9 2.1 1.1 0.9 0.3 0.5 1.1
Notes: 1) For definitions of industry classification, see Appendix Table 1.
2) Figures in 1990-2000 indicate the sum of values from 1990 to 2000.
3) For other data source, see data appendix in the main text.
Table 3 Trends of Japan's Foreign Direct Investment, by Region
Value (US$ million) 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 1990-2000
World total 57,688 42,211 34,988 37,333 41,883 52,699 49,728 54,739 39,852 65,308 49,821 526,251
East Asia & Paciffic 11,257 9,292 8,793 8,843 11,143 15,319 12,629 13,523 8,250 7,666 6,578 113,293
EU-15 13,527 9,012 6,870 7,467 6,176 8,448 7,403 11,119 13,545 24,668 24,521 132,755
Europe & Central Asia 934 459 372 811 208 347 231 245 141 600 510 4,858
Latin America & Caribbean 3,272 2,525 2,393 2,904 4,092 3,375 3,296 5,538 6,131 6,022 4,796 44,344
Middle East & North Africa 2 65 609 212 211 61 142 389 28 35 14 1,768
North America 27,963 19,359 15,237 16,346 19,155 24,263 24,365 21,891 10,719 24,398 13,144 216,840
South Asia 107 43 226 82 198 242 297 783 299 222 191 2,690
Central & South Africa 555 753 244 560 351 388 445 319 435 494 55 4,598
Others 70 703 246 107 350 254 920 933 304 1,202 13 5,101
Share (World = 100.0%) 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 1990-2000
World total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
East Asia & Paciffic 19.5 22.0 25.1 23.7 26.6 29.1 25.4 24.7 20.7 11.7 13.2 21.5
EU-15 23.4 21.3 19.6 20.0 14.7 16.0 14.9 20.3 34.0 37.8 49.2 25.2
Europe & Central Asia 1.6 1.1 1.1 2.2 0.5 0.7 0.5 0.4 0.4 0.9 1.0 0.9
Latin America 5.7 6.0 6.8 7.8 9.8 6.4 6.6 10.1 15.4 9.2 9.6 8.4
Middle East & North Africa 0.0 0.2 1.7 0.6 0.5 0.1 0.3 0.7 0.1 0.1 0.0 0.3
North America 48.5 45.9 43.5 43.8 45.7 46.0 49.0 40.0 26.9 37.4 26.4 41.2
South Asia 0.2 0.1 0.6 0.2 0.5 0.5 0.6 1.4 0.7 0.3 0.4 0.5
Central & South Africa 1.0 1.8 0.7 1.5 0.8 0.7 0.9 0.6 1.1 0.8 0.1 0.9
Others 0.1 1.7 0.7 0.3 0.8 0.5 1.8 1.7 0.8 1.8 0.0 1.0
Notes: 1) For definitions of regional classification, see Appendix Table 2.
2) For other notes and sources, see Table 3.
Table 4 Summary Statistics
Japan
N Mean S.D. Minimum Maximum
ln(FDIi/GDPi) 810 -11.691 2.236 -18.192 -5.199
ln(ePjp/Pi) 1,211 -0.181 0.274 -2.730 1.045
VOLjp 961 0.298 0.914 0.000 14.245
ln(ePus/Pi) 1,211 0.036 0.250 -2.497 1.319
VOLus 949 0.276 0.929 0.000 14.275
Trend 1,524 6.500 3.453 1.000 12.000
ln(wjp/wi) 1,368 2.631 1.561 -0.229 5.770
ln(CUMFDIi/GDPi) 1,114 -10.727 2.653 -17.857 -3.967
US Peg Dummy 1,274 0.133 0.340 0.000 1.000
For the definitions and the data sources of variables, see Data Appendix in the main text
Table 5 Correlation Matrix
N = 529 ln(FDIi/GDPi) ln(ePjp/Pi) VOLjp ln(ePus/Pi) VOLus Trend ln(wjp/wi) ln(CUMFDIi/GDPi US Peg Dummy
ln(FDIi/GDPi) 1.000
ln(ePjp/Pi) -0.052 1.000
VOLjp -0.005 0.315 1.000
ln(ePus/Pi) -0.023 0.785 0.245 1.000
VOLus 0.032 0.295 0.924 0.239 1.000
Trend -0.031 0.097 -0.075 0.130 -0.130 1.000
ln(wjp/wi) 0.004 -0.088 0.069 -0.029 0.135 0.059 1.000
ln(CUMFDIi/GDPi) 0.747 0.029 0.021 0.028 0.027 0.220 -0.132 1.000
US Peg Dummy 0.243 -0.089 0.019 -0.093 -0.079 0.072 -0.054 0.255 1.000
For the definitions and the data sources of variables, see Data Appendix in the main text.
Table 6 Results of ADF t -statistics, by Industry
ln(FDIi/GDPi) ln(ePjp/Pi) ln(ePus/Pi) VOLjp VOLus ln(wjp/wi) ln(CUMFDIi/GDPi)

without with time without with time without with time without with time without with time without with time without with time
time trend trend time trend trend time trend trend time trend trend time trend trend time trend trend time trend trend
Lag order: 1 year

All industry -2.741*** -2.991*** -3.064*** -4.018***
Manufacturing total -2.750*** -2.900*** -3.388*** -3.998***
Food industry -2.895*** -2.921** -1.902** -2.419
Chemical products -2.847*** -3.018*** -2.999*** -4.389***
Primary metals and metal products -2.775*** -2.841** -2.004** -5.478***
General machinery -3.023*** -3.383*** -1.824*** -2.238 -1.828*** -2.233 -2.987*** -3.031*** -3.025*** -2.969*** -1.365 -1.653 -2.958*** -3.756***
Electric machinery -2.436*** -2.808*** -2.413*** -4.165***
Transport equipment -3.351*** -3.388*** -2.882*** -3.300***
Finance, insurance and real estate -2.533*** -2.864*** -2.531*** -3.836***
Wholesale and retail trade -2.936*** -3.414*** -3.565*** -4.633***
Services -2.453*** -2.664** -3.250*** -2.908***
Lag order: 2 years
All industry -2.741*** -2.979*** -3.077*** -4.029***
Food industry -2.895*** -2.921 -1.902*** -2.419**
Primary metals and metal products -2.775*** -2.841*** -2.004*** -5.478***
General machinery -3.023*** -3.383*** -1.813*** -2.196** -1.818*** -2.193* -2.985*** -3.058*** -3.040*** -2.987*** -1.272 -1.555 -2.958*** -3.756***
Services -2.453*** -2.664*** -3.222*** -2.939***
Lag orders: 3 years
All industry -2.774*** -2.990*** -3.088*** -4.031***
Food industry -2.895*** -2.921*** -1.902*** -2.419***
Primary metals and metal products -2.775*** -2.841*** -2.004*** -5.478***
General machinery -3.023*** -3.383*** -1.884*** -2.257** -1.851*** -2.261** -2.971*** -3.048*** -3.044*** -2.975*** -1.264 -1.631 -2.958*** -3.756***
Services -2.453*** -2.664*** -3.135*** -2.827***
Notes: 1) Results of Im, Pesaran and Shin unit root tests are presented. Null hypothesis is that each series of the countries contains unit root while alternative hypothesis is that at least one of the countries is stationary.
2) Figures indicate ADF t -statistics. *, ** and *** indicate statistically significant at 10%, 5% and 1%, respectively.
2) For the definitions and the data sources of variables, see Data Appendix in the main text.
Table 7 Regression Results: Benchmark Model
Dependent variable: ln(FDIi/GDPi)
All industry Manufacturing total Food industry Chemical products Primary metals General machinery Electric machinery Transport equipment Finance, insurance Wholesale Services
Japan and metal products and real estate and retail trade
ln(ePjp/Pi) 12.862*** 15.255*** 23.705*** 21.056*** 20.212*** 20.738*** 20.428*** 19.526*** 16.765*** 15.365*** 17.549***
[28.27] [19.66] [16.15] [16.92] [15.99] [18.00] [18.82] [15.75] [16.80] [31.47] [20.51]
VOLjp -12.445*** -12.396*** -15.543*** -14.802*** -12.974*** -16.640*** -14.004*** -14.626*** -16.217*** -16.124*** -16.532***
[25.21] [16.86] [9.40] [11.46] [10.71] [12.17] [12.50] [10.72] [13.89] [17.32] [15.20]
ln(ePus/Pi) 0.469 5.275*** 2.993 11.061*** 8.804*** 12.280*** 15.756*** 13.670*** 3.248 3.123* 3.656*
[0.43] [3.49] [0.97] [5.64] [4.02] [5.08] [7.54] [9.18] [1.53] [1.76] [1.78]
VOLus -11.738*** -9.180*** -12.797*** -15.752*** -9.970*** -15.129*** -12.935*** -14.811*** -14.502*** -13.033*** -16.221***
[17.15] [16.44] [7.12] [9.58] [8.97] [9.08] [12.66] [11.28] [10.52] [12.11] [12.29]
Trend -0.929*** -1.217*** -0.972*** -1.319*** -1.031*** -1.458*** -1.126*** -1.506*** -1.084*** -1.528*** -1.116*** -1.567*** -1.038*** -1.518*** -1.040*** -1.489*** -0.970*** -1.315*** -1.125*** -1.464*** -1.076*** -1.402***
[39.43] [51.23] [34.15] [41.39] [17.90] [23.77] [28.41] [33.45] [26.33] [40.61] [25.11] [33.35] [30.40] [44.03] [22.76] [54.61] [22.93] [33.92] [39.26] [57.46] [27.89] [35.07]
N 614 602 435 423 189 177 255 243 238 226 251 239 272 260 262 250 302 290 377 365 324 312
Log-Likelihood -1685.75 -1791.78 -1224.83 -1283.36 -569.03 -575.74 -737.67 -758.82 -685.03 -696.47 -709.10 -746.44 -762.77 -794.64 -765.75 -766.49 -837.97 -873.33 -1062.15 -1124.27 -895.07 -946.38
AIC 5.50 5.96 5.65 6.08 6.05 6.54 5.81 6.27 5.78 6.19 5.67 6.27 5.63 6.14 5.87 6.16 5.57 6.04 5.65 6.18 5.54 6.09
Notes: 1) Estimation method is Feasible Generalized Least Squares (heteroscedastic ). Absolute value of t-statistics are in brackets and *, ** and *** indicate statistically significant at 10%, 5% and 1%, respectively.
2) AIC indicates the Akaike's information criteria.
Table 8 Regional Difference of the Effects of Changes in Exchange Rate and Exchange Rate Volatility
East Asia and metal products and real estate and retail trade
ln(ePjp/Pi) 16.192*** 18.570*** 25.771*** 21.748*** 23.977*** 23.543*** 22.097*** 27.867*** 16.252*** 23.522*** 21.700***
[7.37] [7.90] [7.39] [7.80] [7.94] [7.72] [8.19] [8.70] [5.72] [7.15] [7.47]
VOLjp -2.793** -3.451** -5.333** -3.150* -4.744** -5.073** -4.870*** -4.623** -2.470 -5.549** -3.845**
[2.08] [2.35] [2.52] [1.88] [2.49] [2.43] [2.64] [2.42] [1.49] [2.42] [2.25]
ln(ePus/Pi) 0.021 0.446 -2.703 1.354 0.591 -1.676 0.043 9.224** -0.013 -1.213 -2.519
[0.01] [0.16] [0.58] [0.38] [0.16] [0.45] [0.01] [2.03] [0.00] [0.32] [0.73]
VOLus -2.922 -3.670* -3.486 -3.117 -5.828** -6.062** -5.252** -6.711** -1.821 -7.674** -4.290*
[1.50] [1.69] [1.05] [1.19] [2.09] [2.09] [2.06] [2.24] [0.82] [2.54] [1.67]
Trend -1.027*** -1.088*** -1.071*** -1.153*** -1.471*** -1.579*** -1.320*** -1.433*** -1.294*** -1.372*** -1.380*** -1.402*** -1.189*** -1.279*** -1.410*** -1.611*** -1.301*** -1.448*** -1.290*** -1.284*** -1.363*** -1.376***
[16.49] [17.80] [16.47] [16.51] [13.97] [14.22] [16.83] [16.28] [15.70] [15.23] [16.74] [15.41] [16.30] [16.31] [16.24] [14.36] [14.60] [21.11] [14.71] [14.20] [17.22] [16.62]
N 96 96 96 96 80 80 96 96 95 95 96 96 96 96 82 82 89 89 95 95 95 95
Log-Likelihood -256.85 -267.96 -262.48 -276.56 -245.49 -258.13 -279.90 -296.31 -282.04 -295.98 -285.96 -298.63 -274.75 -288.72 -241.16 -260.13 -261.14 -266.38 -288.27 -296.37 -275.17 -287.47
AIC 5.41 5.64 5.53 5.82 6.21 6.53 5.89 6.24 6.00 6.29 6.02 6.28 5.79 6.08 5.96 6.42 5.94 6.05 6.13 6.30 5.86 6.12
Latin America and metal products and real estate and retail trade
ln(ePjp/Pi) 5.066*** 5.093** 10.166*** 8.406*** 12.650*** 12.212*** 13.747*** 2.993* 4.707 7.730*** 7.428***
[3.04] [2.46] [3.08] [2.88] [5.87] [6.52] [6.54] [1.85] [1.31] [4.20] [3.98]
VOLjp -12.613*** -8.663*** -18.151*** -18.860*** -10.278*** -8.178*** -10.997*** -14.803*** -16.329*** -15.585*** -14.867***
[10.79] [7.86] [4.84] [4.54] [7.91] [5.33] [6.82] [6.76] [5.75] [9.51] [7.69]
ln(ePus/Pi) -6.829*** -4.457 0.214 12.422*** 6.735** 11.822*** 13.610*** 5.101* -1.064 1.258 6.385*
[2.87] [1.50] [0.03] [3.31] [1.96] [3.49] [3.75] [1.72] [0.17] [0.37] [1.69]
VOLus -7.892*** -6.184*** -11.198*** -17.995*** -8.734*** -5.115*** -11.493*** -12.444*** -10.549*** -10.237*** -10.765**
[6.71] [5.31] [2.83] [3.96] [6.17] [3.98] [7.96] [5.47] [3.39] [6.44] [4.24]
Trend -1.035*** -1.269*** -1.127*** -1.341*** -0.969*** -1.292*** -1.060*** -1.431*** -0.975*** -1.349*** -1.195*** -1.615*** -1.119*** -1.512*** -1.261*** -1.374*** -0.944*** -1.089*** -1.153*** -1.449*** -1.158*** -1.372***
[16.48] [22.21] [15.34] [19.35] [9.18] [11.35] [9.13] [13.71] [8.97] [18.34] [21.13] [22.02] [21.66] [42.38] [22.76] [16.59] [10.06] [10.82] [15.84] [21.49] [14.26] [16.77]
N 131 131 62 62 20 20 23 23 30 30 18 18 23 23 30 30 41 41 70 70 38 38
Log-Likelihood -378.87 -393.38 -173.77 -182.54 -55.34 -60.65 -64.39 -67.38 -76.56 -83.16 -41.18 -44.07 -58.48 -61.93 -76.34 -83.24 -109.87 -118.63 -194.43 -207.68 -96.97 -108.19
AIC 5.83 6.05 5.70 5.99 5.83 6.36 5.86 6.12 5.30 5.74 4.91 5.23 5.35 5.65 5.29 5.75 5.51 5.93 5.64 6.02 5.26 5.85
Notes: 1) For regional classification, see Appendix Table 2.

Table 9 Alternative Definitions of Exchange Rate Volatility
No control in real exchange rate volatility
and metal products and real estate and retail trade
ln(ePjp/Pi) 14.066*** 16.062*** 23.692*** 21.808*** 20.614*** 21.850*** 21.767*** 20.521*** 18.663*** 18.471*** 19.290***
[21.23] [19.63] [12.96] [16.73] [13.53] [15.21] [17.68] [14.08] [14.34] [20.47] [17.94]
VOLjp -6.022*** -5.223*** -5.483*** -3.696*** -4.517*** -5.121*** -6.191*** -6.093*** -4.793*** -7.660*** -5.014***
[11.27] [10.90] [4.07] [3.11] [4.18] [8.44] [9.47] [16.59] [4.29] [7.34] [5.06]
ln(ePus/Pi) -1.784 3.818** -5.044 8.033*** 5.278** 8.632*** 11.757*** 10.349*** -0.990 0.425 -3.363
[1.52] [2.19] [1.39] [3.23] [2.22] [3.49] [5.67] [4.89] [0.44] [0.24] [1.49]
VOLus -6.236*** -5.155*** 1.277 -1.091 -1.758* -3.004*** -3.876*** -4.074*** -1.038 -5.565*** -1.946
[9.95] [6.74] [0.77] [0.73] [1.68] [4.64] [3.70] [2.91] [0.84] [5.29] [1.40]
Trend -1.083*** -1.363*** -1.103*** -1.431*** -1.262*** -1.701*** -1.340*** -1.718*** -1.253*** -1.735*** -1.324*** -1.741*** -1.178*** -1.724*** -1.198*** -1.657*** -1.207*** -1.512*** -1.279*** -1.645*** -1.317*** -1.692***
[65.65] [62.21] [32.76] [42.55] [20.11] [24.97] [27.33] [32.35] [32.23] [122.30] [24.42] [34.71] [39.19] [40.18] [25.97] [49.79] [24.11] [44.15] [39.60] [81.52] [32.46] [47.40]
N 614 614 435 435 189 189 255 255 238 238 251 251 272 272 262 262 302 302 377 377 324 324
Log-Likelihood -1789.88 -1891.90 -1290.51 -1365.35 -594.26 -635.49 -774.14 -831.80 -715.57 -758.28 -754.80 -809.09 -802.48 -871.28 -798.43 -846.81 -896.45 -945.60 -1134.06 -1202.19 -956.24 -1036.96
AIC 5.84 6.17 5.95 6.29 6.32 6.76 6.10 6.55 6.04 6.40 6.04 6.47 5.92 6.43 6.12 6.49 5.96 6.28 6.03 6.39 5.92 6.42
Control dsitance in real exchange rate volatility

ln(ePjp/Pi) 8.154*** 10.920*** 13.042*** 13.950*** 15.814*** 13.998*** 17.355*** 13.673*** 13.084*** 13.580*** 11.289***
[9.05] [10.46] [8.66] [12.31] [9.05] [8.14] [9.73] [6.37] [10.81] [10.38] [10.08]
var(ePjp/Pi) -1.929*** -5.533*** -7.096*** -3.897*** -6.377*** -4.525** -7.970*** -5.988*** -4.461*** -7.411*** -5.735***
[2.72] [5.61] [4.41] [4.06] [3.87] [2.47] [3.65] [3.50] [4.70] [4.61] [5.17]
ln(ePus/Pi) -4.240*** -3.997*** -9.561*** -1.552 -7.249*** 2.768 -2.581 -5.626** 2.287 -0.217 -4.051**
[4.13] [2.67] [5.13] [0.87] [2.62] [1.11] [1.22] [2.07] [1.28] [0.11] [2.13]
var(ePus/Pi) -1.959*** -4.021*** -5.690*** -1.380* -6.971*** -8.275*** -8.120*** -3.846** -6.125*** -11.361*** -7.045***
[3.83] [4.78] [4.33] [1.72] [4.46] [4.20] [6.03] [2.51] [7.45] [7.07] [5.78]
Trend -0.994*** -1.103*** -1.075*** -1.270*** -1.274*** -1.505*** -1.254*** -1.507*** -1.445*** -1.621*** -1.306*** -1.499*** -1.176*** -1.386*** -1.269*** -1.488*** -1.054*** -1.310*** -1.225*** -1.437*** -1.310*** -1.429***
[31.66] [40.36] [28.50] [40.79] [22.58] [52.41] [29.67] [42.00] [25.62] [28.71] [24.67] [27.75] [19.25] [26.83] [17.08] [21.82] [25.87] [44.09] [26.37] [34.90] [32.14] [45.66]
N 460 469 442 452 260 266 381 391 227 236 184 192 208 216 159 163 363 372 354 364 295 304
Log-Likelihood -1315.16 -1366.78 -1309.70 -1376.96 -801.23 -830.87 -1156.02 -1237.52 -706.54 -758.55 -556.77 -597.30 -639.40 -684.69 -498.74 -525.10 -1085.21 -1142.74 -1064.84 -1129.96 -905.51 -954.68
AIC 5.73 5.84 5.94 6.11 6.19 6.27 6.08 6.35 6.25 6.45 6.08 6.25 6.18 6.37 6.31 6.48 6.00 6.16 6.03 6.23 6.16 6.30
For notes and sources, see Table 7.

Table 10 Regression Results of US dollar Peg
ln(ePjp/Pi) 12.992*** 15.261*** 23.916*** 21.506*** 20.416*** 20.858*** 20.420*** 19.531*** 17.651*** 15.220*** 17.940***
[30.96] [19.56] [16.17] [16.60] [15.89] [18.03] [18.84] [15.64] [16.46] [39.21] [21.47]
VOLjp -12.142*** -12.395*** -15.663*** -15.982*** -12.916*** -16.782*** -14.110*** -14.622*** -17.187*** -15.998*** -16.968***
[26.82] [16.86] [9.45] [10.94] [10.66] [12.23] [12.56] [10.67] [14.31] [18.20] [15.72]
ln(ePus/Pi) 0.408 5.062*** 2.213 10.831*** 8.922*** 12.280*** 15.807*** 13.629*** 3.442 3.289* 3.615*
[0.39] [3.35] [0.72] [5.49] [4.07] [5.08] [7.52] [9.11] [1.59] [1.85] [1.74]
VOLus -11.768*** -9.287*** -12.517*** -15.799*** -10.031*** -15.129*** -13.070*** -14.771*** -14.597*** -13.154*** -16.475***
[17.26] [16.31] [6.92] [9.68] [9.00] [9.08] [12.41] [11.27] [10.55] [11.67] [12.25]
US Peg Dummy 1.397*** -0.895 0.047 -1.681** 0.951 3.965*** 0.972 -1.670 0.550 1.401*** 1.051 n.a. 1.024*** -6.413 0.116 -0.961 3.243*** 0.765 1.501*** -0.163 2.840*** 0.042
[2.91] [1.33] [0.07] [2.00] [0.86] [4.34] [1.28] [1.59] [0.84] [3.51] [0.86] [2.75] [1.37] [0.12] [0.91] [5.15] [0.91] [4.42] [0.56] [3.50] [0.04]
Trend -0.946*** -1.207*** -0.973*** -1.299*** -1.039*** -1.471*** -1.111*** -1.494*** -1.096*** -1.529*** -1.118*** -1.567*** -1.066*** -1.510*** -1.040*** -1.487*** -0.984*** -1.323*** -1.152*** -1.463*** -1.095*** -1.394***
[40.16] [50.98] [33.55] [38.86] [17.91] [22.96] [26.34] [32.77] [25.73] [39.22] [25.14] [33.35] [28.23] [38.67] [22.71] [52.99] [22.51] [32.06] [40.65] [47.36] [28.51] [32.52]
N 614 602 435 423 189 177 255 243 238 226 251 239 272 260 262 250 302 290 377 365 324 312
Log-Likelihood -1684.38 -1790.66 -1224.83 -1281.91 -568.68 -573.04 -737.06 -757.58 -684.87 -694.53 -708.54 -746.44 -759.31 -796.60 -765.78 -766.32 -829.96 -872.96 -1058.41 -1122.95 -889.07 -945.72
AIC 5.50 5.96 5.65 6.08 6.06 6.52 5.81 6.27 5.79 6.18 5.68 6.28 5.61 6.16 5.88 6.16 5.52 6.05 5.64 6.18 5.51 6.09
Notes: 1) US Pegg dummy takes value one if nominal exchange rate of volatility (vis-à-vis US dollar) equal to zero and takes zero otherwise.
2) As for general machinery, we cannot obtain estimates of US Peg Dummy because of multicollinearity.
3) For other notes and sources, see Table 7.
Table 11 Regression Results with Additional Control Variables
ln(ePjp/Pi) 0.359* 0.222 0.089 0.080 0.736 -0.083 0.466 0.853* -0.742* 0.756** 0.895**
[1.75] [0.75] [0.15] [0.21] [1.61] [0.20] [1.10] [1.74] [1.83] [2.46] [2.51]
VOLjp -1.042*** -0.503** -0.267 -0.548* -0.323 -0.083 -0.406*** -0.821* -0.214 -0.826*** -0.903**
[5.51] [2.35] [0.88] [1.66] [1.27] [0.25] [2.71] [1.71] [0.73] [2.59] [2.50]
ln(ePus/Pi) 0.509** 0.421 1.085 0.884** 1.496*** 0.034 0.566 1.546** -1.616*** 1.572*** 0.907**
[2.05] [1.24] [1.35] [1.99] [3.12] [0.07] [1.24] [2.41] [3.02] [3.97] [2.04]
VOLus -0.940*** -0.690*** -0.746* -0.925*** -0.530** -0.340 -0.460** -0.993** -0.201 -0.849*** -0.866***
[5.41] [3.40] [1.88] [2.94] [2.10] [1.05] [2.50] [2.04] [0.67] [2.89] [2.63]
ln(wjp/wi) 0.137*** 0.154*** 0.094*** 0.097*** 0.221*** 0.211*** 0.104*** 0.109*** 0.121*** 0.079 0.130*** 0.179*** 0.040 0.060 0.145*** 0.148*** 0.251*** 0.293*** 0.103** 0.130*** 0.127*** 0.131***
[5.55] [5.94] [3.17] [3.16] [4.48] [3.27] [2.84] [2.67] [2.65] [1.61] [2.72] [3.52] [0.97] [1.42] [3.20] [2.85] [5.93] [6.37] [2.34] [2.70] [3.74] [3.65]
ln(CUMFDIi/GDPi) 1.005*** 1.012*** 1.003*** 1.002*** 0.997*** 0.984*** 1.017*** 1.006*** 0.999*** 0.990*** 1.014*** 1.010*** 1.019*** 1.022*** 1.000*** 0.997*** 1.054*** 1.054*** 0.991*** 1.007*** 0.971*** 0.987***
[110.60] [120.18] [84.07] [100.94] [57.19] [56.38] [75.38] [75.85] [62.61] [69.09] [69.00] [80.02] [75.43] [99.60] [60.04] [61.18] [66.98] [71.64] [79.97] [95.09] [75.35] [87.42]
Trend -0.251*** -0.263*** -0.234*** -0.241*** -0.295*** -0.309*** -0.219*** -0.234*** -0.250*** -0.271*** -0.272*** -0.288*** -0.212*** -0.228*** -0.244*** -0.273*** -0.307*** -0.290*** -0.254*** -0.267*** -0.337*** -0.339***
[28.10] [26.48] [18.80] [17.61] [12.48] [10.01] [13.52] [12.80] [12.22] [12.20] [14.49] [13.46] [12.59] [12.69] [11.33] [10.78] [19.25] [15.88] [18.14] [17.15] [22.21] [21.50]
N 540 529 374 363 160 149 217 206 201 190 222 211 234 223 228 217 266 255 320 309 277 266
Log-Likelihood -770.79 -763.51 -525.68 -514.63 -279.17 -272.07 -322.61 -312.13 -297.79 -282.82 -315.52 -305.51 -325.56 -312.13 -394.45 -383.30 -409.62 -400.20 -460.32 -450.17 -409.38 -396.45
AIC 2.87 2.91 2.84 2.86 3.55 3.72 3.02 3.08 3.01 3.03 2.89 2.94 2.83 2.84 3.50 3.58 3.12 3.18 2.91 2.95 2.99 3.02
ln(ePjp/Pi) 0.365* 0.300 0.340 0.110 0.710 -0.010 0.411 0.737 -0.713* 0.814*** 0.594
[1.78] [0.99] [0.54] [0.27] [1.60] [0.02] [0.99] [1.48] [1.67] [2.70] [1.58]
VOLjp -0.881*** -0.439** -0.140 -0.470 -0.223 0.027 -0.353** -0.539 0.053 -0.757** -0.683*
[4.68] [2.01] [0.43] [1.40] [0.86] [0.08] [2.43] [1.14] [0.18] [2.39] [1.91]
ln(ePus/Pi) 0.581** 0.608* 0.762 0.969** 1.604*** 0.107 0.370 1.397** -1.359** 1.456*** 0.797*
[2.30] [1.79] [0.99] [2.18] [3.51] [0.22] [0.81] [2.21] [2.44] [3.83] [1.73]
VOLus -0.806*** -0.598*** -0.548 -0.871*** -0.521** -0.175 -0.357** -0.723 0.057 -0.762*** -0.709**
[4.57] [2.96] [1.42] [2.80] [2.10] [0.55] [2.31] [1.54] [0.19] [2.61] [2.20]
ln(CUMFDIi/GDPi) 0.991*** 0.992*** 0.993*** 0.992*** 0.969*** 0.968*** 1.004*** 0.991*** 0.989*** 0.982*** 1.008*** 1.003*** 1.019*** 1.021*** 0.989*** 0.983*** 1.035*** 1.026*** 0.984*** 0.998*** 0.969*** 0.978***
[111.03] [120.72] [84.98] [102.85] [59.96] [66.42] [72.26] [80.11] [64.43] [73.32] [71.66] [79.78] [75.90] [98.11] [57.78] [61.33] [66.45] [71.21] [85.63] [97.62] [72.73] [88.20]
Trend -0.238*** -0.250*** -0.224*** -0.232*** -0.288*** -0.279*** -0.214*** -0.232*** -0.233*** -0.260*** -0.256*** -0.264*** -0.205*** -0.214*** -0.226*** -0.250*** -0.291*** -0.271*** -0.247*** -0.254*** -0.318*** -0.320***
[27.88] [28.10] [18.56] [17.40] [11.41] [9.69] [13.25] [13.00] [12.71] [13.48] [14.89] [13.28] [13.06] [12.48] [10.99] [10.96] [17.32] [14.14] [17.56] [16.64] [20.11] [19.72]
N 540 529 374 363 160 149 217 206 201 190 222 211 234 223 228 217 266 255 320 309 277 266
Log-Likelihood -780.86 -772.28 -530.16 -518.81 -282.89 -273.78 -326.25 -314.03 -300.14 -282.77 -315.65 -307.45 -325.39 -311.34 -398.70 -385.81 -420.36 -413.55 -463.24 -453.36 -414.59 -400.94
AIC 2.91 2.93 2.86 2.88 3.59 3.73 3.04 3.09 3.03 3.02 2.88 2.95 2.82 2.83 3.53 3.59 3.19 3.27 2.92 2.96 3.02 3.04
For notes and sources, see Table 7.

Appendix Table List of Countries
Japan's partner countries from 1989 to 2000

East Asia & Paciffic Sweden Puerto Rico Senegal
Australia United Kingdom Trinidad and Tobago South Africa
Brunei Other Europe & Central Asia Uruguay Tanzania
Cambodia Cyprus Venezuela, RB Uganda
* China Czech Republic Middle East & North Africa Zambia
Fiji Hungary Algeria Zimbabwe
French Polynesia Iceland Bahrain
* Hong Kong, China Kazakhstan Egypt, Arab Rep.
* Indonesia Liechtenstein Iran, Islamic Rep.
Kiribati Monaco Israel
Korea, Dem. Rep. Norway Jordan
* Korea, Rep. Poland Kuwait
Lebanon Romania Oman
Macao, China Russian Federation Qatar
* Malaysia Slovak Republic Saudi Arabia
Mongolia Slovenia United Arab Emirates
Myanmar Switzerland North America
New Caledonia Turkey Bermuda
New Zealand Ukraine Canada
Northern Mariana Islands Uzbekistan United States
Papua New Guinea Yugoslavia, FR (Serbia/Montenegro) South Asia
* Philippines Latin America Bangladesh
Samoa Argentina Bhutan
* Singapore Aruba India
Solomon Islands Bahamas, The Maldives
* Taiwan Barbados Nepal
* Thailand Belize Pakistan
Vanuatu Brazil Sri Lanka
Vietnam Cayman Islands Central and South Africa
EU-15 Chile Angola
Austria Colombia Cameroon
Belgium Costa Rica Cote d'Ivoire
Denmark Dominican Republic Gabon
Finland Ecuador Ghana
France El Salvador Guinea
Germany Guatemala Kenya
Greece Honduras Liberia
Ireland Jamaica Madagascar
Italy Mexico Mauritius
Luxembourg Netherlands Antilles Mozambique
Netherlands Panama Namibia
Portugal Paraguay Niger
Spain Peru Nigeria
Notes: * indicates East Asia. For data sources of FDI flows, see Data Appendix in the main text.
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Exchange Rate, Exchange Rate Volatility and Foreign Direct Investment

Article in World Economy · February 2004

Kozo Kiyota Shujiro Urata

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Kozo Kiyota Shujiro Urata

2. A Brief Review of Previous Studies

2.3. Sources of Real Exchange Rate Movements

3 For the definition of short-run and long-run measures, see Table 1.

2.4. Extension of Previous Studies

3.2. Description of the Data

=== Table 2 and Table 3 ===

=== Table 4 and Table 5 ===

3.3. Econometric Issues: Heterogeneity and Nonstationarity

where y ti is a variable under consideration, ∆y ti− s = y ti − y si and p

=== Table 6 ===

4. The Estimation Results

=== Table 7 ===

6 See, for more detail, Baltagi (2001).

=== Table 8 ===

5.2. Alternative Definitions of Volatility

FDI ti eti Pt  eti Pt 

volatility is zero and takes zero otherwise.

=== Table 10 ===

5.4. Additional Control Variables

FDI ti eti Pt wt CUMFDI ti−1

=== Table 11 ===

Foreign Direct Investment

GDP and relative labor costs

12 The correlation of the natural log of relative wage, (

Volatility --- --- --- --- --- --- ---

--- --- --- --- --- --- ---

Volatility positive positive positive negative negative

ln(FDIi/GDPi) ln(ePjp/Pi) ln(ePus/Pi) VOLjp VOLus ln(wjp/wi) ln(CUMFDIi/GDPi)

Lag order: 1 year

Notes: 1) For regional classification, see Appendix Table 2.

Control dsitance in real exchange rate volatility

For notes and sources, see Table 7.

For notes and sources, see Table 7.

Japan's partner countries from 1989 to 2000

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