Costs of entry and exit from financial markets and capital flows to Developing Countries

Though the theory of irreversible investment under uncertainty is now well understood, no attempt has been made to empirically evaluate its predictions for foreign investment decisions. Yet costs of entry and exit from financial markets due to government restrictions certainly represent an important source of irreversibility. In this paper, a model with partial irreversibility of investment is used to derive a negative relation between costs of entry and exit from financial markets and foreign investment. Such a theoretical relation is consistent with empirical findings from a panel of 25 developing countries in 1987–1991.