Causality relations between foreign direct investment and portfolio investment volatility

Following the liberalization of financial markets, Goldstein and Razin (2006) show that there is an information based trade-off between foreign direct investment and foreign portfolio investment, our paper examines the causality relations between foreign direct investment and volatility of foreign portfolio investment. Utilizing monthly and quarterly data set of Czech Republic, Poland, Russia and Turkey, volatility of portfolio investments, which indicated evidence of ARCH effects for all four countries, have been estimated by best fitting GARCH (p,q) models. Further, potential causality has been examined by Granger (1969), Sims (1972) and Toda and Yamamoto (1995) test methods. Results indicated that, for Russia and Turkey foreign direct investment has a significant cause on portfolio investment volatility. However for Czech Republic and Poland, there is no such significant relationship has been found. Finally further investigation of a possible structural break due to EU membership could not provide such evidence for Czech Republic and Poland in related variables.