Does the Feldstein–Horioka puzzle exist among South Asian countries? A regime‐switching approach

• Published date: 01 August 2020
• Author: Ranjan Kumar Mohanty,Suresh Kumar Patra
• DOI: http://doi.org/10.1002/pa.2061
• Date: 01 August 2020

ACADEMIC PAPER

Does the Feldstein–Horioka puzzle exist among South Asian

countries? A regime-switching approach

Suresh Kumar Patra

1

| Ranjan Kumar Mohanty

2

1

Xavier School of Economics, Xavier

University, Bhubaneswar, Odisha, India

2

National Institute of Public Finance and

Policy (NIPFP), New Delhi, India

Correspondence

Ranjan Kumar Mohanty, National Institute of

Public Finance and Policy (NIPFP), 18/2,

Satsang Vihar Marg, Special Institutional Area,

New Delhi 110067, India.

Email: ranjanmohanty85@gmail.com

Abstract

A plethora of literature has been undertaken to study the validity of the Feldstein–

Horioka (FH) puzzle. However, divergent views continue to persist in the FH puzzle

literature. This study explores the empirical validity of the FH puzzle in the case of

South Asian countries using annual data from 1960 to 2017. Both panel data

approach and Markov-switching regression approach are used to empirically analyze

the FH puzzle. The results of the cointegration test confirm the long-run relationships

between saving and investment in the selected South Asian countries. The results of

Markov-switching regression confirm that the saving-retention coefficient has shifted

from high to low values and also from low to high values. Thus, the FH puzzle exists

for a particular time period and mostly depends on the regime shifts in the South

Asian countries. The results of panel fully modified ordinary least squares (FMOLS)

and dynamic ordinary least squares(DOLS) methods also confirm that FH puzzle holds

for the South Asian countries. Therefore, the study suggests that any saving promo-

tion policies are desirable for enhancing investment among the South Asian regions.

KEYWORDS

capital mobility, Feldstein–Horioka puzzle, Markov-switching regression, saving–investment

association, South Asia

JEL CLASSIFICATION

C12; C22; C23; E27; F21

1|INTRODUCTION

The Feldstein–Horioka (FH) puzzle has widely attracted the attention

of researchers and policymakers after the publication of an influen-

tial paper by Feldstein and Horioka (1980). They found a strong

saving–investment correlation with a large degree of capital mobility,

which is widely known as FH puzzle.

1

Since then, it has always been

a highly debated and most explored issue because of its policy rele-

vance regarding saving–investment associations and capital mobility.

The FH puzzle is regarded as “the mother of all puzzles”in interna-

tional monetary economics by Obstfeld and Rogoff (2000). Numerous

theoretical and empirical studies have tried to resolve this puzzle using

a distinct set of nations, datasets, model specifications, and sophisti-

cated econometric techniques.

2

Some studies have questioned the FH

framework as a means of evaluating the degree of international mobil-

ity of capital (Coakley, Kulasi, & Smith, 1996; Ho, 2003; Obstfeld &

Rogoff, 1995). The y interpret that t he strong saving–investment rela-

tionship could be due to intertemporal budget constraint or long-term

solvency constraint on current account(Coakley et al., 1996; Coakley &

Kulasi, 1997; Jansen, 1997; Pelgrin & Schich, 2008), domestic and

global production shocks (Chu, 2012), size of countries (Harberger,

1980; Baxter & Crucini, 1993; Corbin, 2001; AmirKhalkhali, Dar, &

AmirKhalkhali, 2003; Oskooee & Chakrabarti, 2005), and technological

and demographic variables (Attanasio, Picci, & Scorcu, 2000; Tay-

lor, 1994).

Many studies have supported the validity of FH methodology in

evaluating capital mobility and explain the puzzle using cross section,

time series, and panel techniques based on the methodological and

Received: 3 September 2019 Revised: 29 September 2019 Accepted: 21 November 2019

DOI: 10.1002/pa.2061

J Public Affairs. 2020;20:e2061. wileyonlinelibrary.com/journal/pa © 2020 John Wiley & Sons, Ltd 1of14

https://doi.org/10.1002/pa.2061