Foreign direct investment in R&D and exchange rate uncertainty

The current practice in the literature on the impact of exchange rate uncertainty on foreign direct investment is to consider exchange rate volatility. In this paper, we demonstrate the importance of considering also covariances and apply the theoretical arguments to a UK industry panel of FDI in R&D. An increase in the covariance of the euro and sterling, which would be a certain consequence of the UK’s entry into European Monetary Union, will increase foreign R&D into the UK. Increased volatility of the euro-dollar exchange rate tends to relocate R&D investment from the Euro Area into the UK.