The proximity-concentration tradeoff under uncertainty

In this article, we analyse the firm's choice between serving a foreign market through exports or through foreign affiliate sales in an environment characterized by country-specific shocks to the cost of production. Our model predicts that country pairs with less-correlated output fluctuations trade more, relative to affiliate sales, whereas countries with more-volatile fluctuations are served relatively more by exporters than by foreign affiliates selling abroad. Using detailed data on trade and affiliate sales, we find empirical support for our model's predictions.