Abstract This study investigates the effect of the exchange rate on foreign direct investment (FDI). The exchange rate effect manifests itself theoretically but remains ambiguous empirically. In the literature, (a) FDI is treated predominantly as a continuous variable, while the discrete nature of FDI decisions is neglected; (b) FDI data are in aggregated form, masking the true firm‐level exchange‐rate–FDI relationship; and (c) regression models adopted are ill‐suited to analyse exchange rate and FDI data as both of these display different time‐series properties. To overcome these problems, we propose the use of (i) a discrete choice model with a mixed logit application to capture discrete investment decisions and firm heterogeneity; (ii) cross‐section dimension to reduce the problem arising from the time‐series dimension; and (iii) firm‐level location choice data and real exchange rate data reflecting international price level differences so that (i) and (ii) are implemented. With these new features, we perform an empirical analysis using firm‐level data on the location choice of Chinese outward FDI during 2005–2016. Our estimation results detect a significant exchange rate effect not accounted for previously, explaining why the evidence for the effect has been mixed across studies.
Shi et al. (Tue,) studied this question.
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