FOREIGN DIRECT-INVESTMENT, EXCHANGE-RATE VARIABILITY AND DEMAND UNCERTAINTY

Variable real exchange rates influence the location of production faci lities chosen by a multinational: With risk averse investors and fixed productive factors, parent companies should not be indifferent to pro duction location, even with identical expected costs of production acr oss countries. If a nonnegative correlation exists between export dema nd and exchange rate shocks, the multinational optimally locates some productive capacity abroad. The capacity share abroad increases as exc hange rate volatility rises and becomes more correlated with export de mand shocks. These results are confirmed using quarterly U.S. bilatera l foreign direct investment flows with Canada, Japan, and the United K ingdom.