The asset market approach assumes that whether foreigners are willing to hold claims in monetary form depends on an extensive set of investment considerations or drivers. These drivers include the following:
- Relative real rates are a major consideration for investors in foreign bonds and short-term money market instruments.
- Prospects for economic growth and profitability are an important determinant of cross border equity investment in both securities and foreign direct investment.
- Capital market liquidity is particularly important to foreign institutional investors. Cross-border investors are interested not only in the case of buying assets, but also in the case of selling those assets quickly for fair market value if desired.
- A country’s economic and social infrastructure is an important indicator of that country’s ability to survive unexpected external shocks and to prosper in a rapidly changing world economic environment.
- Political safety is exceptionally important to both foreign portfolio and direct investors. The outlook for political safety is usually reflected in political risk premiums for a country’s securities and for purposes of evaluating foreign direct investment in that country.
- The creditability of corporate governance practices is important to cross-border portfolio investors. A firm’s poor corporate governance practices can reduce foreign investors’ influence and cause subsequent loss of the firm’s focus on shareholder wealth objectives.
- Contagion is defined as the spread of a crisis in one country to its neighboring countries and other countries that have similar characteristics- at least in the eyes of cross-border investors. Contagion can cause an “innocent” country to experience capital flight with a resulting depreciation of its country.
- Speculation can both cause a foreign exchange crisis or make an existing crisis worse.