On strategic vertical foreign investment

We investigate the strategic incentives for vertical foreign direct investment by oligopolistic firms under exchange rate uncertainty. Domestic final good firms meet their input requirements either by investing abroad and producing directly through a subsidiary (intra-firm trade) or by buying from an oligopolistic market abroad (inter-firm trade). Firms undertaking vertical investment can bid up the input price faced by their rivals through strategic purchase. We demonstrate the possibility of vertical foreclosure, multiple equilibria, complementarity and bunching of investment decisions. Increase in the variability of exchange rate has positive effects on foreign direct investment and trade in the intermediate good; an appreciation of investor's currency has similar effects.