<blockquote>
  <p>An alternative is to use stocks rather than flows, but this does not
  seem to fit very well with the theory of gravity equations which seem
  to me to inherently deal with flow concepts.</p>
</blockquote>

<p>Using stocks rather than flows and avoiding the disinvestment issue is a good alternative. Gravity equations have been shown to do a good job fitting <strong>stocks of FDI</strong> (see the Handbook of International Economics, <a href="http://www.sciencedirect.com/science/article/pii/B9780444543141000033" rel="nofollow noreferrer">Gravity Equations: Workhorse, Toolkit, and Cookbook</a>, page 149). </p>

<p><a href="http://www.sciencedirect.com/science/article/pii/S0022199607000815" rel="nofollow noreferrer">This paper</a> considers a model in which FDI takes the form of acquisitions. Using the discrete choice framework in a way that resembles <a href="http://www.princeton.edu/~erossi/courses_files/EKn.pdf" rel="nofollow noreferrer">Eaton and Kortum (2002)</a>, the authors develop a gravity equation for FDI which fits the data well. <a href="http://onlinelibrary.wiley.com/doi/10.1111/j.1467-9442.2011.01656.x/full" rel="nofollow noreferrer">This paper</a> extends the model to greenfield investment by imagining that instead of bidding for assets, each corporation selects the best "investment project" across all host countries.</p>

CC BY-SA 3.0
2017-01-26T21:53:09.060Z
2017-01-26T21:53:09.060Z
emeryville
<p>I am trying to model Foreign Direct Investment (FDI) flows and am facing several issues;</p>

<p>There is the well-known condition that under heteroskedasticity log-linearized OLS models are biased and inconsistent. <a href="http://personal.lse.ac.uk/tenreyro/jensen08k.pdf" rel="nofollow noreferrer">Santos-Silva and Tenreyro (2006)</a> suggest using Poisson pseudo-maximum-likelihood (PPML) to overcome this, and subsequently PPML, negative binomial and Poisson modeling became commonplace in the literature, but...</p>

<p>... FDI flows are often negative (divestment), which cannot be accommodated by count data models or PPML. Negative flows are economically meaningful and therefore cannot just be dropped without loss of consistency. An alternative is to use stocks rather than flows, but this does not seem to fit very well with the theory of gravity equations which seem to me to inherently deal with flow concepts. </p>

<p>Can anyone suggest an appropriate estimator? I have heard the suggestion of multinomial logit (where dep.var. is share of global FDI flows) but this would also seem to falter in the case of a negative flow.</p>

CC BY-SA 3.0
2017-01-26T13:33:51.750Z
Cross-posted on Stats Stack Exchange [here](http://stats.stackexchange.com/questions/258254/estimation-technique-for-fdi-gravity-model-with-negative-and-zero-observations).
Richard Hardy
<econometrics><investment><regression><open-economy-macro>
Appropriate estimator for FDI "gravity" model
Robert Brown
# Appropriate estimator for FDI "gravity" model

(Asked by: username_0 on 2017-01-26)

I am trying to model Foreign Direct Investment (FDI) flows and am facing several issues;

There is the well-known condition that under heteroskedasticity log-linearized OLS models are biased and inconsistent. [Santos-Silva and Tenreyro (2006)](http://personal.lse.ac.uk/tenreyro/jensen08k.pdf) suggest using Poisson pseudo-maximum-likelihood (PPML) to overcome this, and subsequently PPML, negative binomial and Poisson modeling became commonplace in the literature, but...

... FDI flows are often negative (divestment), which cannot be accommodated by count data models or PPML. Negative flows are economically meaningful and therefore cannot just be dropped without loss of consistency. An alternative is to use stocks rather than flows, but this does not seem to fit very well with the theory of gravity equations which seem to me to inherently deal with flow concepts.

Can anyone suggest an appropriate estimator? I have heard the suggestion of multinomial logit (where dep.var. is share of global FDI flows) but this would also seem to falter in the case of a negative flow.

**Tags:** econometrics, investment, regression, open-economy-macro

> **Comments:**
> **username_1**: Cross-posted on Stats Stack Exchange [here](http://stats.stackexchange.com/questions/258254/estimation-technique-for-fdi-gravity-model-with-negative-and-zero-observations).  

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## 1 answers

### Answer by username_2 on 2017-01-26. Score: 0 | Accepted answer

> An alternative is to use stocks rather than flows, but this does not
> seem to fit very well with the theory of gravity equations which seem
> to me to inherently deal with flow concepts.

Using stocks rather than flows and avoiding the disinvestment issue is a good alternative. Gravity equations have been shown to do a good job fitting **stocks of FDI** (see the Handbook of International Economics, [Gravity Equations: Workhorse, Toolkit, and Cookbook](http://www.sciencedirect.com/science/article/pii/B9780444543141000033), page 149).

[This paper](http://www.sciencedirect.com/science/article/pii/S0022199607000815) considers a model in which FDI takes the form of acquisitions. Using the discrete choice framework in a way that resembles [Eaton and Kortum (2002)](http://www.princeton.edu/~erossi/courses_files/EKn.pdf), the authors develop a gravity equation for FDI which fits the data well. [This paper](http://onlinelibrary.wiley.com/doi/10.1111/j.1467-9442.2011.01656.x/full) extends the model to greenfield investment by imagining that instead of bidding for assets, each corporation selects the best "investment project" across all host countries.


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