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| Title: | Can Financial Frictions Account for the Cross-Section Feldstein-Horioka Puzzle? |
| Authors: | Bai, Yan
Zhang, Jing |
| Keywords: | Feldstein and Horioka, financial frictions, international finance |
| Issue Date: | 6-Apr-2006 |
| Series/Report no.: | 005 |
| Abstract: | This paper studies the famous Feldstein and Horioka finding, which is a high correla-tion between long period averages of savings rates and investment rates across countries. We first confirm the Feldstein-Horioka finding with a more recent data set, and then show that a calibrated complete markets model generates a cross-section savings-investment correlation close to zero. Thus, the cross-section Feldstein-Horioka finding is a puzzle to the complete markets model and further research is needed to account for this puzzle. We next explore roles of financial frictions in accounting for the cross-section Feld-stein-Horioka puzzle. The most popular incomplete markets model, the bond model with natural borrowing constraints, cannot account for the cross-section Feldstein-Horioka puzzle. We then propose the bond model with enforcement constraints in which uncon-tingent debt contracts are enforced by the threat of permanent exclusion from the mar-kets. This model generates endogenous borrowing constraints, which capture the incen-tives of countries to repay their debts instead of their abilities to repay under natural bor-rowing constraints, and accounts for the cross-section Feldstein-Horioka puzzle. |
| Appears in Collections: | International Policy Center - Working Paper Series
Economics, Department of
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| IPC-working-paper-005-ZhangBai.pdf | | 4384Kb | Adobe PDF | View/Open |
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