Exploring the Causality Links between Financial Markets and Foreign Direct Investment in Africa

Abstract

This paper sets out to explore the causality links between financial markets and foreign direct investment (FDI) in Africa. We use proxies for the banking sector and stock market to capture financial market development. We run separate estimations for the banking and stock market samples. Therefore, the sample size differs based on the sample being estimated. The banking sample is made up of 42 countries, whilst the stock market sample is made up of 16 countries. We use data covering the period 1970–2007 for the bank sample whilst for the stock market sample we use data covering the period 1990–2007. We use a 2SLS panel instrumental variable approach to obviate simultaneous causality bias. Our results suggest that a more advanced banking system can lead to more FDI flows. Also higher FDI flows can lead to the development of the domestic banking system. Countries with better-developed stock markets are likely to attract more FDI. We also find that FDI flows can lead to the development of the domestic stock market. Our results imply significant complementarities and feedback between financial markets and FDI in Africa.