The differential rates of return hypothesis

The differential rates of return hypothesis postulates that capital flows from countries with low rates of return to countries with high rates of return move in a process that eventually leads to the equality of real rates of return.The rationale for this hypothesis is that firms considering FDI behave in such a way as to equate the marginal return on capital and its marginal cost.The hypothesis is obviously based on the assumption of risk neutrality, making the rate of return the only factor upon which the investment decision is made.