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Globalisation, Volatility and Investment

This project investigates the impact of globalisation of the capital market on investment and real interest rates, focusing on the role of volatility in asset prices including exchange rates and stock markets. Previous theoretical and empirical work has focused on the relationship between exchange rate volatility and foreign direct investment (FDI), but no consensus has been reached. In theory, volatility may reduce investment in the short run, but could serve to raise investment over the longer term. In the light of the inconclusiveness of previous empirical work and the underlying theoretical indeterminacy, there is a clear case for an empirical investigation of the effects of exchange rate variability on investment. Our modelling framework simultaneously incorporates the determination of exchange rates and the determination of investment and real interest rates. In addition to exchange rate uncertainty we also examine the effects of stock market volatility. The empirical work uses both a small panel of data for 10 leading OECD countries and a larger 25-country panel. In addition to assessing the impact of volatility, we are able to estimate the extent of capital market globalisation and capital mobility, which enables an assessment to be made of their relationship to volatility and investment.