Do Goods and Financial Market Frictions Explain the Feldstein-Horioka Puzzle? (thesis)
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Author
Kisker, Maria Esther Hope
Subject
Washington and Lee University -- Honors in Economics
Capital market -- Mathematical models
Capital movements -- Mathematical models
Saving and investment
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Thesis; [FULL-TEXT FREELY AVAILABLE ONLINE] Maria Esther Hope Kisker is a member of the Class of 2021 of Washington and Lee University. Feldstein and Horioka (1980) argue that in a world of perfect capital mobility, if one regressed investment on savings, the coefficient would be 0. When they found coefficients of between 0.87 and 0.91, they concluded that capital markets are not integrated. This surprising result was dubbed the "Feldstein-Horioka puzzle" and has been called one of the six major puzzles in international macroeconomics. Ford and Horioka (2016) purport to "solve" this puzzle by arguing that this high coefficient can be explained by frictions in either goods markets, financial markets, or both, because capital markets alone cannot facilitate net transfers of capital. I test the explanatory power of Ford and Horioka's proposed solution to the puzzle using observations dating back to 1870. I find that Ford and Horioka's explanation has strong explanatory power and connect their theory to the Mundell-Fleming model. Maria Kisker