Feeding the Tigers: An Analysis of the Relationship between Foreign Direct Investment, Stock Market Prices, and Government Bond Yields in East Asia

Abstract

This paper aims to investigate the relationship between foreign direct investment (FDI) and both stock market index prices and ten-year government bond yields in the Four Asian Tigers after the Asian Financial Crisis of 1997-1999. I utilize a VAR model to test for Granger causality between each pair of variables quarterly from 2000 to 2015, then run a system of simultaneous equations using a Three Stage Least Squares (3SLS) analysis to further extend the analysis for each pair. After running the Granger causality test, I find that in South Korea, foreign direct investment Granger causes the KOSPI price at the 99% level, while the ten-year government bond yield Granger causes the amount of foreign direct investment at the 95% level. In Hong Kong, foreign direct investment Granger causes the price of the Hang Seng Index at the 99% level, while in Taiwan, there is a bi-directional causal relationship between the price of the TAIEX index and foreign direct investment at the 90% level. In Singapore, the price of the Straits-Times Index Granger causes foreign direct investment at the 90% level. However, the results obtained from the 3SLS analysis only partially support the findings for South Korea and Hong Kong and contradict the results for Taiwan and Singapore produced from the Granger causality test, thus indicating the need for further econometric analysis on the relationship between each pair of variables.