Prof. Jayanth R. Varma's Financial Markets Blog

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Prof. Jayanth R. Varma's Financial Markets Blog, A Blog on Financial Markets and Their Regulation

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Mon, 29 Aug 2005

Is the Feldstein Horioka puzzle dead or dying?

In today’s Financial Times, Martin Wolf writes that

“The principal determinant of the pattern of capital flows is, it turns out, divergent savings rates. ... because investment rates were closer together than savings rates, the world's capital exporters were countries with high savings rates and the importers were ones with low savings rates.” (Martin Wolf, “Capital flow must change course”, Financial Times, August 29, 2005.)

Does this mean that one of the oldest puzzles of international financial economics, the Feldstein Horioka puzzle is dead or dying? Feldstein and Horioka showed that the cross sectional regression coefficient of investment rates on savings rates was close to unity. (Feldstein, M. and C. Horioka, 1980, “Domestic savings and international capital flows”, Economic Journal, 90, 314-329). This coefficient has fallen since then. Obstfeld and Rogoff noted that the regression coefficient had fallen to 0.60 for the early and mid 1990s as opposed to the 0.89 obtained by Feldstein and Horioka for the 1960s and early 1970s (Obstfeld, M. and K. Rogoff, 2000, “The six major puzzles in international macroeconomics: Is there a common cause?”, NBER Working Paper 7777).

Perhaps, freer capital markets are destroying what is left of the puzzle?

Posted at 11:16 on Mon, 29 Aug 2005     View/Post Comments (3)     permanent link

Mon, 22 Aug 2005

Institutional Investors

Granit San has an interesting paper at SSRN about institutional and individual trading (San, Granit, “Who Gains More by Trading - Individuals or Institutions?”, June 2005.

The conclusion of the paper is that institutions are momentum traders who buy stocks that have done well in the last few quarters and sell those that have not done well. On the other hand individual investors trade in a more contrarian manner and earn higher returns. The superior performance of individuals persists after adjusting for risk using (a) the CAPM or (b) the three factor model of Fama and French or (c) the four factor model of Carhart. The data is consistent with the hypothesis that institutions are noise traders while individuals are informed, rational traders.

What is more interesting is that the same conclusion is true even during the technology stock bubble of the late 1990s. Individual entered technology stocks and exited them more rationally than institutions and earned superior returns during the process as well.

In India, the regulatory regime for foreign portfolio investors has been that foreign institutional investors (FIIs) are welcome while foreign individuals and hedge funds are barely tolerated. San's results would suggest that this policy is completely misguided. If FIIs are momentum investors, then their presence would exacerbate the booms and busts in the stock market. Encouraging non institutional investors would be a far better idea.

Posted at 11:25 on Mon, 22 Aug 2005     View/Post Comments (1)     permanent link

Tue, 09 Aug 2005

Markets, marketplaces and eBay

In a free-wheeling article on markets and market places, in today's Financial Times, columnist John Kay discusses the problems at the big exchanges in Chicago, London, Frankfurt and New York. He also finds time to talk about the Fulton fish market in New York and the world's largest produce market at Ringis near Paris (John Kay, “In search of a quiet courtier”, Financial Times, August 9, 2005). After that, he has this to say about eBay:

“The most successful for-profit marketplace today is eBay. But it has not yet made much money and the issue for its future is whether it can reconcile shareholder expectations with the iron law of natural monopoly - to exploit it is to lose it”.

Though Kay does not mention this, the big difference between eBay and the rest is that while eBay centralizes trading like the others, it does not centralize settlement. This allows eBay to handle millions of separate non fungible physical settlements - something that none of the big exchanges or clearers can even dream of.

Posted at 06:03 on Tue, 09 Aug 2005     View/Post Comments (0)     permanent link