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IMF and Boston College, respectively. The authors wish to thank Ravi Balakrishnan, Stephen Bond, Elie Canetti, Peter Dattels, Hali Edison, Gian Maria Milesi-Ferretti, and Martin Muhleisen for valuable discussions. They also wish to thank Inessa Love for the use of her panel VAR program.
IMF Balance of Payment Statistics, 2006. Percentage increase in gross financial account outflows, all countries, from 1994 to 2005.
For example, net bond (including Treasuries, agencies, and corporates) purchases by foreigners accounted for more than 88% of portfolio inflows in the 12 months through October 2006, and more than 100% of the current account deficit during that period.
Home bias is often characterized, in terms of the capital asset pricing model, as an ex ante preference for domestic over foreign assets that keeps investors from moving to the mean-variance-efficient frontier.
In the real world, this assumption is approximately true for bonds, and clearly not true with regard to equities. Because we are focusing on the bond case, we maintain it here.
The data cover all flows to the United States, and so incorporate both private and public flows, which, as suggested by the example, are often difficult to distinguish in practice. Admittedly, bond purchases by public entities may be insulated to some extent from market forces. However, public entities, like private ones, are often sensitive to implicit interest rate differentials, in many cases weighing the cost of issuing domestic debt against the yield earned on foreign reserves
The only exception is in the case of China, where 10-year bond yields are not available, and so short-term interest rates are used.
The dividing point of December 2001 was chosen to coincide roughly with the beginning of a new global business cycle, and also to allow enough observations in each period to perform useful analysis. As a robustness check, all of the tests performed in the paper were also done with the two periods divided at December 2000 and, alternatively, at December 1999. The results did not change substantially in either case, and the results in the former (December 2000) case were quite close to those reported here. Details available from the authors.
Counterpart economies were selected on the basis of data availability, financial market liquidity, and importance as a source of private sector inflows to the United State. Brazil and China were also included as large emerging market economies.
In this context, Hsiao recommends the use of a model in which independent and dependent variables are all first-differenced. However, this procedure eliminates the spread levels information which, from the theoretical model, is a determinant of bond inflows.
That is, that the ηi in the specification yit = xitβ + ηi + υit are correlated with the xit.
This conjunction of a high estimated coefficient with a much higher standard error in the case of the fixed effects regression likely reflects multicollinearity between the spread variable and a subset of the country dummies. This is confirmed by separate regressions of the spread variable on the country dummies for Period 2 (not reported).
See Love, Inessa and Lea Zicchino, “Financial Development and Dynamic Investment Behavior: Evidence from Panel Vector Autoregression”