Foreign Direct Investment and Debt Financing in Emerging Economies

Sheung Kan LUK, Tianxiao Zheng

Research output: Contribution to journalArticlepeer-review


The rich dynamics of capital flows is an important characteristic of business cycles in emerging market economies. In the data external debt is always procyclical, while FDI is procyclical only in normal times. We provide a microfounded rationale for this pattern by linking financial shocks to capital flows. For this purpose, we build a small open economy model in which firms are subject to borrowing constraints, and are either owned domestically or by foreign investors who purchase firms through FDI. During a financial crisis, the valuation gap per unit net worth between foreign and domestic investors widens, which triggers more FDI inflow. Our model produces business cycle moments consistent with empirical observations.

Original languageEnglish
Pages (from-to)863-905
Number of pages43
JournalJournal of Money, Credit and Banking
Issue number4
Publication statusPublished - 1 Jun 2020

Scopus Subject Areas

  • Accounting
  • Finance
  • Economics and Econometrics

User-Defined Keywords

  • debt financing
  • E44
  • F41
  • F44
  • F62
  • FDI
  • financial crisis
  • financial frictions


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