The pecking order of cross-border investment

Is there a pecking order of cross-border investment in that countries become financially integrated through some types of investment rather than others? Using a novel database of bilateral capital stocks for all types of investment – foreign direct investment (FDI), portfolio equity securities, debt securities as well as loans – for a broad set of 77 countries, we show that such a pecking order indeed exists. The paper focuses on two key determinants of this pecking order: information frictions and the quality of host country institutions. Overall, we find that in particular FDI, and to some extent also loans, are substantially more sensitive to information frictions than investment in portfolio equity and debt securities. We also show that the share as well as the size of FDI that a country receives are largely insensitive to institutional factors in host countries, while portfolio investment is by far the most sensitive to the quality of institutions. This provides new evidence in favour of some hypotheses but contradicts others put forward in the literature on trade in financial assets.