What Drives Capital Flows? The Case of Cross-Border M&A Activity and Financial Deepening

What macroeconomic and financial variables play key roles in the foreign direct investment decision of firms? This question is addressed in this paper using a large panel data set of cross-border Merger amp; Acquisition (Mamp;A) deals for the period 1990-1999. Various econometric specifications are built around the simple gravity model commonly used in the trade literature.Interestingly, financial variables and other institutional factors seem to play a significant role in Mamp;A flows. In particular the size of financial markets, as measured by the stock market capitalization to GDP ratio, has a strong positive association with domestic firms investing abroad. This result points to the importance of domestic financial conditions in stimulating international investment during the boom years of 1990s, and accords with the significant drop in cross-border Mamp;As in recent years