The Feldstein-Horioka Puzzle: A Panel Smooth Transition Regression Approach

Abstract

This paper proposes a panel threshold specification of the Feldstein Horioka puzzle. Based on a panel of 24 OECD countries (1960-2000), we test the influence of various threshold variables (degree of openness, size, demography) on the saving-retention coefficient. Given this objective, we estimate various specification of a Panel Smooth Threshold Regression (PSTR) model recently developed by Gonzalez, Teräsvirta and Van Dijk (2005). One of our main results is the existence of strong threshold effects in the relationship between domestic investment and saving: whatever the transition mechanism specified, each test strongly reject the linearity assumption. Moreover, these specifications allow both cross country heterogeneity and the instability in the degree of capital mobility. Consequently, it is possible to give estimates of Feldstein-Horioka coefficient at any time and for each country in the sample.

Keywords: Feldstein Horioka Puzzle, Panel Smooth Threshold Regression Models, saving-investment association, capital mobility

JEL Classification: C23, F21, F32