How Different are FDI and FPI Flows?: Distance and Capital Market Integration

Abstract

The availability of bilateral capital flows between countries has given rise to a number of papers attempting to understand trends and determinants of capital flows between country pairs. Almost without exception, the papers find that the gravity model fits the data quite well Specifically, while economic sizes of the host and source (measured by GDP, population etc) appear to positively impact bilateral flows in most cases, distance -- broadly proxying some sort of transactions and /or information frictions -- stands out as consistently hindering all types of capital flows. But does greater distance hinder both foreign portfolio investment (FPI) and foreign direct investment (FDI) flows equally? In other words, does distance change the composition of capital flows? This is the specific question that this paper focuses on, differentiating between total FDI, FDI via mergers and acquisitions (M&As) and FPI.