At the heart of the studies on the FDI-uncertainty connection is the following
question: does an increase (or decrease) in uncertainty associated with return from
production operations located abroad lead to a rise or fall in FDI by multinationals?
Of course, in the present context changes in uncertainty refer to changes in the
volatility (as opposed to changes in the level or the mean value) of any relevant
variable that affects the future return on facilities located abroad. Such variables
include future exchange rates, taxes and other stochastic return-related variables in
the host country. The stated question is unsettled in the literature and conflicting
answers have emerged from theoretical and empirical studies, in particular when
uncertainty emanates from exchange rate variations. Assuming that uncertainty
emanates from product quality and firms are risk-neutral with linear technology,
Ethier (1986) showed a positive correlation between multinationals FDI and uncertainty.
Itagaki (1981), Cushman (1985, 1988) found a positive correlation between
exchange rate volatility and FDI. The study by Goldberg and Kolstad (1995)
concluded that under risk neutrality by multinationals, there is no statistical connection
between allocation of production facilities abroad and exchange rate volatility.
However, under risk aversion, the Goldberg and Kolstad study also showed a
positive correlation between exchange rate volatility and the share of production
facilities located abroad. In contrast, Siegel (1983) and Bailey and Tavlass (1991)
rejected such a positive correlation, and Aizenman (1992) and Campa (1993)
reported a negative correlation between exchange rate volatility and FDI under risk
neutrality. Authors such as Baldwin ( 1989) and Dixit ( 1989) focused on the hysteresis