The Effects of Innovation on Foreign Portfolio Investment: The Role of Institutions and Risk-Taking

TL;DR

This paper investigates how innovation influences foreign portfolio investment (FPI) across 60 countries from 1996 to 2021, highlighting the roles of institutions and risk-taking in this relationship.

Contribution

It provides causal evidence that innovation boosts FPI, especially equity inflows, and explores how institutional quality and risk environment modulate this effect.

Findings

Innovation increases FPI, more so for equity than debt.

Higher institutional quality amplifies the effect of innovation on FPI.

Countries with higher risk-taking environments attract more FPI.

Abstract

We study whether and how innovation intensity attracts foreign portfolio investment (FPI) using a panel of 60 countries from 1996 to 2021. Using an instrumental variable strategy based on regional shift-share and global push instruments, we estimate the causal response of debt and equity inflows to innovation intensity in the host country. We find that innovation increases FPI, with larger effects for equity than debt inflow. Moreover, the effect of innovation on equity inflow increases with technological development and institutional quality, whereas the effect on debt inflow is positive and significant only at high levels of these factors. We also find that countries with a higher risk-taking environment attract more FPI and that equity inflow responses are immediate and persistent, whereas debt inflow responses are modest and dampen over time.