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| Type | Master's Thesis |
| Scope | Discipline-based scholarship |
| Title | Home bias and the international mobility of capital - the influence of the European Economic and Monetary union on the degree of capital mobility |
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| Institution | University of Zurich |
| Faculty | Faculty of Economics, Business Administration and Information Technology |
| Date | 2010 |
| Zusammenfassung | How mobile are nancial markets internationally? Since Feldstein and Horioka (1980) examined the association between domestic savings and investment and provided evidence of a highly positive correlation, this question has attracted a lot of interest. Their puzzling results contradicted the conventional wisdom of globally integrated nancial markets as it was argued that under perfect international capital mobility, domestic investment should not depend on domestic savings. In globalized markets, domestic savings has to ow independently of the source to the most e cient global uses and should not be correlated with domestic investment. At the end of the last century, new developments across Europe made the question of the degree of capital mobility even more essential. The introduction of the Euro as a common currency has changed economic policy making across Europe. With the uni cation of monetary policy in 1999, European Economic and Monetary Union (EMU) member countries have lost the nominal exchange rate as adjustment mechanism. Hence, alternative adjustment instruments are necessary in order to deal with asymmetric shocks in the Euro-area, and capital mobility is one of these adjustment instruments. Capital mobility allows residents to insure their income against country-speci c output shocks. Furthermore, a high degree of capital mobility can stabilize the level of domestic investment when shocks a ect saving capacities asymmetrically. On these grounds, and with the intention of contributing to the existing pool of evidence, this thesis investigates the degree of capital mobility for all EU countries over the time period 1980 - 2009 with emphasis on the pre- and post-introduction periods. The thesis is structured in four main parts. First, it analyzes the advantages and disadvantages of integrated nancial markets. In general, the bene ts of integration stem from four main considerations: the advantages of international risk sharing and intertemporal trade for consumption smoothing; the enhanced discipline of policymakers to avoid overexpansionary scal and monetary policies; improved market allocation; and the positive e ects of free moving capital ows on economic growth. In contrast, Keynesian as well as post-Keynesian economists doubt the theoretical bene ts of integrated markets and have outlined the potential drawbacks of nancial liberalization. Particularly, the enforcement of contracts in supranational markets, the loss of autonomy of scal and monetary policy, the concentration of capital ows to a small number of countries as well as economic instabilities are mentioned in the academic literature. Moreover, it is illustrated that capital mobility, xed exchange rates, and monetary autonomy represent an impossible trinity, which means that at most two of these three desirable economic and political goals can be accomplished at the same time. In the second part, the main aspects of the history of the transition toward the EMU are covered. Furthermore, economic arguments are provided about the e ects of the founding of the EMU on the degree of capital mobility may be. It is pointed out that the harmonization and standardization of regulations, the improved transparency as well as the decreased transaction and information costs, the alternation of political goals of economic policy as well as the abolition of the intra-European currency risks may increase the degree of capital mobility in Europe. Additionally, the formation of the EMU has shifted the view from a national basis to a Euro basis and induced a new phenomenon, the Euro bias. In the third part, the most important capital mobility measures used in the economic literature are reviewed. By emphasizing the capital mobility measure of Feldstein and Horioka (1980), it is shown that its intuitive simplicity proves to be deceptive because there are substantial problems of identi cation and estimation as savings as well as investment are both endogenous variables. Moreover, this thesis outlines alternative explanations for the puzzling results of Feldstein and Horioka (1980). Besides low capital mobility, these ndings can also be attributed to the solvency constraint, current account targeting, home bias, domestic and external savings substitutability, country size, or exogenous shock e ects. In the nal and empirical part, the degree of capital mobility of European countries is examined by means of the Feldstein-Horioka approach. More speci cally, the cross-sectional regression approach of Feldstein and Horioka (1980) as well as the single equation error correction model of Jansen (1996) are used for all EU-27 countries over the sample period 1980 - 2009. The results of both approaches exhibit a high degree of capital mobility for all investigated countries over the time period 1999 - 2009. Even though these ndings can be justi ed by the progressive nancial integration as it is under way in Europe, the high level of integration of Eastern European capital markets is rather surprising. Two decades ago, these countries were command and control economies; however, these days, they display nearly the same level of nancial market integration as Western European countries. This shift is of notable importance with respect to potential enlargement of the EMU in the future since only under an approximately equal degree of integration can an e cient single monetary policy be implemented. Furthermore, both the cross-sectional and the time-series analysis indicate that the EMU member states had already accomplished full capital market integration prior to the introduction of the Euro. Although this outcome is somewhat striking, it can be explained by the strong interdependence of EMU countries as well as the already reduced exchange rate risk as a result of the European Exchange Rate Mechanism that was launched in 1979. One limitation of this thesis is that in most cases, it was not feasible to conduct the cross-sectional as well as the time-series analysis over longer time periods owing to a lack of time-series data. Hence, it would be advantageous to attempt to gather more comprehensive quarterly data sets for all European countries in future studies. If this research can be achieved, it might be possible to obtain a more comprehensive knowledge of the impact of the EMU on the degree of capital mobility in Europe. |
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