Exports and foreign direct investment in the presence of downside risk

AbstractThis study analyses the impact of downside risk on the flow of exports, foreign direct investment (FDI), and their joint pattern. Existing studies in this field have not considered the effects of risk asymmetry or downside risk because they describe risk only by variance; therefore, this study attempts to fill this gap. Downside risk is measured by the semi‐deviations of demand shocks and relates to country demand in the destination market. Using a panel of bilateral industry‐level data on trade and affiliate sales, and a panel of bilateral country‐level data on exports and FDI for many home and destination countries, I find that downside deviations of demand shocks affect the flows of exports, FDI, and their joint pattern. By focusing on downside risk, I present novel results. The results show that downside risk explains significant variation in the flow of exports, FDI, and in the proximity‐concentration tradeoff. Additionally, by conducting joint estimations of variance and semi‐deviations, I show that negative effects of demand risk are mostly due to the downside risk, and that downside volatility is more appropriate than the total volatility captured by the variance.