Time and frequency domain causality Testing: The causal linkage between FDI and economic risk for the case of Turkey

Abstract

This study aims to explore the causal relationship between economic risk and foreign direct investment (FDI) inflows for the case of Turkey. With the aim of establishing robust findings for the research in mind, both traditional and modern causality techniques are utilized; time domain Granger (1969, Investigating Causal Relations by Econometric Models and Cross-Spectral Methods. Econometrica 37: 424-438.), Toda and Yamamoto (1995, Statistical Inference in Vector Autoregressions with Possibly Integrated Processes. Journal of Econometrics 66 (1-2): 225-250.), Fourier Toda-Yamamoto and frequency domain Breitung and Candelon (2006, Testing for short- and long-run causality: A frequency-domain approach. Journal of Econometrics 132 (2): 363-378.) spectral causality test. Our empirical findings reveal that; economic risk changes in Turkey significantly lead to changes in FDI inflows. However, there is no evidence of causality running from FDI to economic risk. The findings imply that economic risk is an essential determinant of FDI inflows in Turkey. Our findings are compatible with historical macroeconomic developments in Turkey and imply important policy implications. The results of this study can be generalized for other emerging economies that have similar macroeconomic environments, in order to create useful policy implications regarding FDI inflow.