Foreign direct investment and psychic distance: a gravity model approach

The study of the foreign direct investments (FDI) has, in last decades, captured the interest of several scholars that study, on one hand which variables are crucial in the FDI choices, on the other hand the impact of some variables on the level of FDI between two countries. In this paper we present an empirical analysis, by means of the gravity model, to test the relationship between FDI, GDP, geographical and psychic distance. This distance may be interpreted as an obstacle to the knowledge of foreign markets. In literature, yet few works have explored the effect of psychic distance on FDI, focusing mostly on market selection, entry mode and performance prediction. Furthermore, the use of the Hofstede's index, often used as proxy of psychic distance, it has been shown to be inadequate. To overcome this limit we consider in our application the multidimensionality of the psychic distance by using several variables.