Sovereign wealth funds, cross-border investment bias and institutions : the case of Arab countries

Abstract EN

SWF surpassed US$ 5.5 trillion in assets in 2014, growing nine-fold since 2002.

Typically, SWFs have the choice to pursue either domestic (home) investments or abroad.

However, despite the presence of highly endowed SWFs in the Arab region, relatively low cross-border SWFs funds are invested in capital importing Arab economies.

This paper, therefore, analyses SWF capital allocation decisions between the home country and abroad by estimating the determinants of the probability of investing abroad (extensive margin) as well as the level of investment (intensive margin).

In particular, we ask whether SWF investment decisions, at both the extensive and the intensive margins, are largely determined by economic factors- e.g.

profitability, effectiveness of economic governance and control of corruption- or are also influenced by strategic considerations, such as geopolitical interests.

Our findings, based on a baseline gravity-type model, show that, while foreign investors have a positive bias for the Arab destination countries at the extensive margin level, there is a negative bias against them at the intensive one.

Yet, effective economic governance institutions and control of corruption and higher relative profitability of investment tend to reduce, but not eliminate, this bias at the extensive margin, while they completely eliminate it at the intensive margin.

On view of the evidence that the size of SWFs investments is fully explained by the extended model and the starkly low quality of economic governance institutions in the Arab investment recipient countries, the latter is likely to be the main factor behind the relatively low cross-border investments in the Arab world.