Contents lists available at ScienceDirect Economic Systems journal homepage: www.elsevier.com/locate/ecosys Impact of an unexplained component of real exchange rate volatility on FDI: Evidence from transition countries Suzana Balaban a, ⁎, Dejan Živkov b , Ivan Milenković c a Faculty of Economics in Subotica, University of Novi Sad, Stevana Hatale 12, 21400, Bačka Palanka, Serbia b Novi Sad School of Business, University of Novi Sad, Vladimira Perića Valtera 4, 21000, Novi Sad, Serbia c Faculty of Economics in Subotica, University of Novi Sad, Segedinski put 9-11, 24000, Subotica, Serbia ARTICLEINFO JEL classifcation: C22 C33 C36 F21 F31 Keywords: Exchange rate volatility GARCH FDI Transition countries SYS-GMM ABSTRACT The aim of this paper is to examine the impact of an unexplained component of real exchange rate volatility on FDI in transition economies. We make an attempt to overcome some problems associated with previous studies; the aggregation problem, inadequate measures of volatility, short-run focus and the endogeneity problem. Using a GARCH specifcation, we focus on long-run volatility, while we control for the endogeneity problem by applying SYS-GMM estimation. The obtained results show that the impact of the unexplained component of real exchange rate vo- latility on FDI difers among economic activities since 2000. As part of the re-estimation exercise, we use two alternative measures of volatility to avoid arbitrariness. The obtained results are to a large extent in accordance with the frst one. 1. Introduction There is a growing number of studies analysing the impact of diferent determinants on foreign direct investment (FDI) in transition countries (see, e.g., Damijan et al., 2003; Hanousek et al., 2011; Acaravci and Ozturk, 2012; Nicolova, 2013; Savaiu et al., 2013; Kejžar, 2016; Andrijić and Barbić, 2018). According to Jensen (2004); Chaido et al. (2014) and Estrin and Uvalic (2013), this is to be expected, keeping in mind that foreign capital has played a signifcant role in these countries throughout the twenty-year transition period from centrally planned to market economies. During the early 2000s, foreign investors required only a few minimal conditions – basic security, beginnings of economic recovery and modest improvements in the business environment (see, e.g., Masso, 2002; Shrikhandle, 2002; Nakamura et al., 2012). In this period, the majority of FDI entering transition economies was related to large privatization projects. Almost twenty years later, attention started to shift to other determinants (see, e.g., Rodriguez and Bustillo, 2015; Yean et al., 2018). One of these is certainly exchange rate volatility. Due to the fact that exchange rate volatility infuences expected profts, uncertainty about future exchange rate volatility can afect FDI decisions. Another reason why exchange rate volatility could be a determinant of FDI in transition countries emerged partly from the prospect of the European monetary union. However, despite a growing literature analysing the impact of diferent determinants on FDI in transition countries, there are only few studies that examine the infuence of exchange rate volatility on FDI. We strive to fll this gap. There are a few potential problems associated with the analysis of the efect of exchange rate volatility on FDI. First, the majority https://doi.org/10.1016/j.ecosys.2019.100719 Received 2 February 2018; Received in revised form 11 December 2018; Accepted 21 February 2019 ⁎ Corresponding author. E-mail addresses: suzana.kolar@yahoo.com (S. Balaban), dejanzivkov@gmail.com (D. Živkov), ivan.milenkovic@pr.ac.rs (I. Milenković). Economic Systems 43 (2019) 100719 Available online 01 October 2019 0939-3625/ © 2019 Elsevier B.V. All rights reserved. T