Article ID | Journal | Published Year | Pages | File Type |
---|---|---|---|---|
963576 | Journal of International Money and Finance | 2012 | 18 Pages |
Abstract
This study shows that the Feldstein-Horioka puzzle resembles a spurious ratio correlation due to a common deflator (Pearson 1896/7). Empirically, the Feldstein-Horioka specification and its counterpart with an arbitrary deflator - final domestic demand - give similar results. Monte Carlo results also indicates that the slope β and R2 of the ratio regression are upward biased. Theoretically, assuming each of the original undeflated variables are linear homogeneous functions of the deflator and random disturbances, formulas for β and R2 are derived. As saving and investment rates are numerically small relative to the disturbances, both β and R2 are predominantly determined by the disturbances and they tend towards unity when the disturbances are close in magnitude. The Feldstein-Horioka results are therefore noisy, though not entirely spurious, and do not necessarily reflect a strong correlation between investment and savings.
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Economics and Econometrics
Authors
Kam Hon Chu,