Many less developed countries have experienced prolonged periods of expansions and reversals in foreign investment inflows. This paper presents a simple game-theoretic model that can explain hysteretic patterns of serial correlation in investment behavior. We develop a sequential move game of coordinated investment played by short-run players under the changing economic environment and demonstrate that in a unique equilibrium of the game, the economy fluctuates over multiple static equilibria, generating hysteresis.
JEL Classification Numbers: C72, C73.

Key Words: economic fluctuation; hysteresis; strategic complementarity; sequential move game; random payoff; equilibrium selection; global game.

Japanese Economic Review 55 (2004), 311-320. PDF file
First draft: April 23, 2001; this version: August 26, 2003. PDF file