# 97-036/2 (1997-03-30)

Santanu Roy; Jean-Marie Viaene, Erasmus University Rotterdam
vertical foreign investment; foreclosure; exchange rate uncertainty; intra-firm trade
JEL codes:
D43; F2; F31

We investigate the strategic incentives for vertical foreign investment by risk-neutraloligopolistic firms and the effect of exchange rate uncertainty. Firms competing in a domesticfinal good market meet their input requirements either by investing abroad and producing theirinput requirement through a foreign subsidiary or by importing at the market price in anoligopolistic intermediate good market abroad. Investing firms can bid up the input price facedby their rivals through strategic purchase. We show that an increase in foreign exchangevariability has a positive effect on vertical foreign direct investment and on trade in theintermediate good. We demonstrate the possibility of multiple equilibria as well ascomplementarity and herding in investment decisions.