Jennifer Schneider - 978-3-653-01915-5 Downloaded from PubFactory at 01/11/2019 11:08:42AM via free access European Business Cycle Convergence Jennifer Schneider - 978-3-653-01915-5 Downloaded from PubFactory at 01/11/2019 11:08:42AM via free access Hohenheimer Volkswirtschaftliche Schriften Herausgegeben von Prof. Dr. Michael Ahlheim, Prof. Dr. Thomas Beißinger, Prof. Dr. Ansgar Belke, Prof. Dr. Harald Hagemann, Prof. Dr. Robert Jung, Prof. Dr. Sibylle Lehmann, Prof. Dr. Andreas Pyka, Prof. Dr. Nadine Riedel, Prof. Dr. Ulrich Schwalbe, Prof. Dr. Peter Spahn, Prof. Dr. Gerhard Wagenhals Band 69 Jennifer Schneider - 978-3-653-01915-5 Downloaded from PubFactory at 01/11/2019 11:08:42AM via free access Jennifer Schneider European Business Cycle Convergence Portfolio Similarity and a Declining Home Bias of Private Investors Jennifer Schneider - 978-3-653-01915-5 Downloaded from PubFactory at 01/11/2019 11:08:42AM via free access Bibliographic Information published by the Deutsche Nationalbibliothek D 100 ISSN 0721-3085 I SBN 978-3-631-63974-0 (Print) E-ISBN 978-3-653-01915-5 (E-Book) DOI 10.3726/978-3-653-01915-5 © Peter Lang GmbH Internationaler Verlag der Wissenschaften Frankfurt am Main 2013 PL Academic Research is an Imprint of Peter Lang GmbH www.peterlang.de The Deutsche Nationalbibliothek lists this publication in the Deutsche Nationalbibliografie; detailed bibliographic data is available in the internet at http://dnb.d-nb.de. Open Access: The online version of this publication is published on www.peterlang.com and www.econstor.eu under the international Creative Commons License CC-BY 4.0. Learn more on how you can use and share this work: http://creativecommons.org/licenses/by/4.0. All versions of this work may contain content reproduced under license from third parties. Permission to reproduce this third-party content must be obtained from these third-parties directly. This book is available Open Access thanks to the kind support of ZBW – Leibniz-Informationszentrum Wirtschaft. Jennifer Schneider - 978-3-653-01915-5 Downloaded from PubFactory at 01/11/2019 11:08:42AM via free access 5 Preface Die vorliegende Dissertation entstand im Zeitraum von 2006 bis 2010, während ich als externe Doktorandin am Institut für VWL, Lehrstuhl für Außenwirtschaft an der Universität Hohenheim tätig war. Ich möchte mich bei den Menschen bedanken, die zum Fortschreiten der Arbeit beigetragen haben. Mein besonderer Dank gilt meinem Doktorvater, Herrn Prof. Dr. Ansgar Belke (Universität Duisburg-Essen, Lehrstuhl für Volkswirtschafts- lehre, insb. Makroökonomik) für die wissenschaftliche Betreuung der Arbeit und seine wertvollen Diskussionsbeiträge. Darüber hinaus schätze ich die Möglich- keiten, die er mir zum Austausch mit anderen Wissenschaftlern eingeräumt hat, sehr. Herzlichen Dank an Herrn Prof. Dr. Hans-Peter Burghof, der freundlicherwei- se das Zweitgutachten übernommen hat und Herrn Prof. Dr. Harald Hagemann als Vorsitzenden beim Kolloquium. Ohne den Rückhalt meines Mannes und meines privaten Umfelds wäre die Dissertation nicht zustande gekommen. Für die Motivation und Flexibilität vielen Dank! Jennifer Schneider - 978-3-653-01915-5 Downloaded from PubFactory at 01/11/2019 11:08:42AM via free access Jennifer Schneider - 978-3-653-01915-5 Downloaded from PubFactory at 01/11/2019 11:08:42AM via free access 7 Content Tables ................................................................................................................. 11 Graphs ................................................................................................................ 13 Abbreviations ..................................................................................................... 15 Variables ............................................................................................................. 17 A. Introduction ................................................................................................... 19 1. Motivation .............................................................................................. 19 B. Theoretical and Empirical Background ......................................................... 23 2. Business Cycle Convergence and Consumption .................................... 23 2.1 Optimal Currency Area Criteria ...................................................... 23 2.2 Financial Market Integration and Business Cycle Convergence ..... 25 2.3 Consumption.................................................................................... 29 2.3.1 Consumption Function .......................................................... 29 2.3.2 Consumption-wealth-linkage ................................................ 31 2.3.3 A Side Note on Financial Systems and Monetary Policy Transmission ......................................................................... 35 2.3 The Context of Consumption and Business Cycles ......................... 38 3. Portfolio Theory ..................................................................................... 39 3.1 Motivation ....................................................................................... 39 3.2 Basics of Modern Portfolio Theory ................................................. 41 3.2.1 Core Elements of Portfolio Theory ....................................... 41 3.2.2 The Efficient Frontier ............................................................ 44 3.2.3 The Single Index Model ........................................................ 47 3.3 Capital Asset Pricing Model ............................................................ 49 3.3.2 The Standard Model .............................................................. 49 3.3.3 Shortcomings of the Standard CAPM ................................... 52 3.3.4 Empirical Findings ................................................................ 53 3.4 International Asset Pricing Model and the Home Bias Phenomenon .................................................................................... 55 Jennifer Schneider - 978-3-653-01915-5 Downloaded from PubFactory at 01/11/2019 11:08:42AM via free access 8 3.4.2 IAPM ..................................................................................... 55 3.4.3 Home Bias – Empirical Background ..................................... 57 3.4.4 Explaining Home Bias........................................................... 60 3.4.4.1 Rational Explanations .............................................. 60 3.4.4.2 Behavioural Finance ................................................ 62 3.5 IAPM – A Plausible Starting Point? ................................................ 65 C. Empirical Analysis ......................................................................................... 69 4. Home Bias – Status quo in Europe......................................................... 70 4.1 Development of Private Financial Wealth ....................................... 70 4.2 Development of Foreign Investment ............................................... 75 4.3 Calculation of Home Bias................................................................ 83 4.4 Status quo of Home Bias ................................................................. 87 4.5 The Market Portfolio as the Ideal Portfolio ..................................... 90 4.6 Return on Investment of the Country Strategies .............................. 95 4.7 Volatility of Return.........................................................................100 4.8 Contribution of Portfolio Returns to Consumption Convergence ..103 4.9 Concluding Remarks ......................................................................106 5. Similarity of Portfolios in Europe .........................................................107 5.1 Calculation......................................................................................108 5.2 Results ............................................................................................110 5.3 Portfolio Similarity and Home Bias ...............................................114 6. Consumption and Business Cycle Correlation ......................................119 6.1 Data and Estimation Method ..........................................................119 6.2 Results / Correlations Coefficients .................................................121 6.3 Summary of Results for Portfolio Similarity and Correlation ........124 7. Model ....................................................................................................129 7.1 General Outline and Variables........................................................129 7.2 Econometric Model ........................................................................134 7.2.1 Formal Analysis and Model Specification ...........................134 7.2.2 Approach ..............................................................................138 7.2.3 Consumption Correlation .....................................................141 7.2.4 GDP Correlation ...................................................................143 7.2.5 Two-stage Least-squares and General Method of Moments ...............................................................................144 7.2.5.1 Model ......................................................................144 7.2.5.2 Results.....................................................................148 7.2.6 Summary ..............................................................................152 Jennifer Schneider - 978-3-653-01915-5 Downloaded from PubFactory at 01/11/2019 11:08:42AM via free access 9 D. Political Implications and Summary .............................................................157 8. Political Implications.............................................................................157 8.1 Reasons for Political Actions .........................................................157 8.2 Reasons for Portfolio Dissimilarity ................................................159 8.3 Solutions Discussed in Literature ...................................................160 8.4 Current Political Discussion of Solutions .......................................161 8.5 Target Group for Measurements .....................................................164 9. Summary ...............................................................................................167 9.1 Hypothesis 1 ...................................................................................168 9.2 Hypothesis 2 ...................................................................................168 9.3 Hypothesis 3 ...................................................................................170 9.4 Hypothesis 4 ...................................................................................170 9.5 Hypothesis 5 ...................................................................................171 9.6 Hypothesis 6 ...................................................................................171 9.7 Hypothesis 7 ...................................................................................172 9.8 Outlook ...........................................................................................173 References .........................................................................................................175 Data Appendices ................................................................................................185 Jennifer Schneider - 978-3-653-01915-5 Downloaded from PubFactory at 01/11/2019 11:08:42AM via free access Jennifer Schneider - 978-3-653-01915-5 Downloaded from PubFactory at 01/11/2019 11:08:42AM via free access 11 Tables Table 1: Selection of Empirical Studies on Home Bias ................................ 58 Table 2: Proportion of Average Investment to Foreign Investment .............. 81 Table 3: Home Bias – EMU Countries ......................................................... 88 Table 4: Home Bias – Non-EMU Countries ................................................. 88 Table 5: Deviations from Optimal Portfolio Weights ................................... 92 Table 6: Comparison of Portfolio Returns .................................................... 97 Table 7: Average Absolut Loss ....................................................................100 Table 8: Comparison of Portfolio Volatilities ..............................................102 Table 9: Interdependence of SPEC and Home Bias .....................................115 Table 10: Data Availability GDP and Consumption ......................................120 Table 11: Variables ........................................................................................130 Table 12: Unit Root Test Statistics ................................................................135 Table 13: Variables, Descriptive Statistics ....................................................140 Table 14: Results Consumption Correlation with RELINC ...........................141 Table 15: Results GDP Correlation................................................................143 Table 16: Summary of Preconditions for 2SLS .............................................147 Table 17: Results of the Second Stage Regression – Original Results ..........149 Table 18: Results of First and Second Stage Estimation – After Adjustment .....................................................................................151 Table 19: Summary of Criteria ......................................................................154 Table 20: Summary of Criteria – Result Side, Low Correlated Countries .....155 Table 21: Summary of Criteria – Result Side, Well-integrated Countries .....156 Table 22: Data for Classification of Target Countries ...................................166 Table 23: Target Countries for Policy Implications .......................................166 Table 24: Summary of Hypotheses ................................................................168 Jennifer Schneider - 978-3-653-01915-5 Downloaded from PubFactory at 01/11/2019 11:08:42AM via free access Jennifer Schneider - 978-3-653-01915-5 Downloaded from PubFactory at 01/11/2019 11:08:42AM via free access 13 Graphs Graph 1: Transmission Channels from Similar Portfolios to Business Cycle Convergence ......................................................................... 22 Graph 2: Marginal Propensity to Consume Out of Wealth in Different Countries ......................................................................................... 35 Graph 3: The Efficient Frontier ..................................................................... 44 Graph 4: The Efficient Frontier – No Borrowing Allowed ............................ 46 Graph 5: The Market Portfolio....................................................................... 50 Graph 6: CAPM – The Security Market Line ................................................ 51 Graph 7: Private Net Financial Wealth per Head ........................................... 71 Graph 8: Sources of Net Financial Wealth .................................................... 72 Graph 9: Proportion of Bonds and Shares of Private Net Financial Wealth ............................................................................................. 73 Graph 10: Proportion of Bonds and Shares vs. Private Net Financial Wealth per Head ............................................................................. 74 Graph 11: (Unweighted) Average Proportions of Home Country and Foreign Investment ......................................................................... 76 Graph 12: Comparison of Foreign Investment................................................. 76 Graph 13: Investment Inside EMU – Outside Home Country ......................... 78 Graph 14: EMU-investment of Non-EMU Countries ...................................... 78 Graph 15: Factor of Foreign Investment in Neighbour Countries to Other Foreign Countries ........................................................................... 79 Graph 16: Development of Home Bias (EMUcountries) ................................. 89 Graph 17: Development of Home Bias (GDP Weights) .................................. 90 Graph 18: The World Market Portfolio ........................................................... 91 Graph 19: Deviation from Market Portfolio – EMU-Countries ....................... 93 Graph 20: Deviation from Market Portfolio – Non-EMU Countries ............... 94 Graph 21: Risk Return Plot .............................................................................103 Graph 22: Average Difference of Annual Portfolio Returns ..........................104 Graph 23: Annual Portfolio Returns per Country ...........................................105 Graph 24: Difference of Annual Portfolio Returns in All Country-pairs ........106 Graph 25: Averaged SPEC .............................................................................110 Graph 26: Development of SPEC for All Country-pairs ................................111 Jennifer Schneider - 978-3-653-01915-5 Downloaded from PubFactory at 01/11/2019 11:08:42AM via free access 14 Graph 27: Development of SPEC for Non-EMU Country-pairs ....................112 Graph 28: Development of SPEC for EMU-country-pairs .............................113 Graph 29: Home Bias vs. Portfolio Similarity vs. Foreign Investment...........116 Graph 30: Portfolio Return vs. SPEC .............................................................117 Graph 31: Median Development of Consumption Correlation Coefficients...122 Graph 32: Median Development of GDP Correlation Coefficients ................123 Graph 33: Consumption per Head ..................................................................125 Graph 34: Map: Quantiles of Portfolio Similarity (Specialisation Index SPEC) ............................................................................................127 Graph 35: Map: Quantiles of Consumption Correlation .................................127 Graph 36: Map: Quantiles of GDP Correlation ..............................................128 Graph 37: Map: Portfolio Similarity and Consumption Correlation ...............128 Graph 38: Map: Portfolio Similarity and Business Cycle Correlation ............129 Graph 39: Consumption Correlation vs. SPEC Index .....................................131 Graph 40: GDP Correlation vs. SPEC Index ..................................................133 Graph 41: Separate Estimation .......................................................................139 Graph 42: Two-stage Least-squares Approach ...............................................145 Jennifer Schneider - 978-3-653-01915-5 Downloaded from PubFactory at 01/11/2019 11:08:42AM via free access 15 Abbreviations 2SLS Two-stage Least-squares AUT Austria BEL Belgium BUL Bulgaria CAPM Capital Asset Pricing Model CPIS Coordinated Portfolio Investment Survey DEN Denmark DS Datastream EMU European Monetary Union ESP Spain EST Estonia FAAR Foreign Asset Acceptance Ratio FGLS Feasible Generalized Least Squares estimation FIN Finland FRA France GER Germany GRE Greece HUN Hungary IAPM International Capital Asset Pricing Model IMF International Monetary Fund ITA Italy n.a. not available NET The Netherlands NOR Norway POR Portugal ROM Romania SLO Slovak Republic SWE Sweden Jennifer Schneider - 978-3-653-01915-5 Downloaded from PubFactory at 01/11/2019 11:08:42AM via free access Jennifer Schneider - 978-3-653-01915-5 Downloaded from PubFactory at 01/11/2019 11:08:42AM via free access 17 Variables CPT consumption correlation SPEC specialisation index RELFW relative financial wealth RELINC relative income GDP GDP correlation Jennifer Schneider - 978-3-653-01915-5 Downloaded from PubFactory at 01/11/2019 11:08:42AM via free access Jennifer Schneider - 978-3-653-01915-5 Downloaded from PubFactory at 01/11/2019 11:08:42AM via free access 19 A. Introduction 1. Motivation One issue for currency areas such as the European Monetary Union (EMU) is that not necessarily one size fits all, i.e. the interest rate setting of the central bank cannot consider different states of the economy in different member countries. A country in recession would prefer low interest rates to stimulate the economy; whereas, for a country in boom, low interest rates might cause inflation. As Mundell (1961) – in his fundamental work – puts it, an optimal currency area is an economic unit that is independent from national borders. Only if all countries taking part in the monetary union behave as an economic unit and react similar to asymmetric shocks can a common monetary policy react. Otherwise, contradictory signals for the interest setting might be a consequence and might raise costs for being a member of a monetary union. Most economists agree that, so far, the countries participating in the EMU do not have synchronised business cycles (see e.g. Artis, 2003; Gros and Hefeker, 2004). To reduce the costs of giving away power over monetary policy, a business cycle convergence of the participating countries would lead to less ambiguous indicators for monetary policy decisions. But which factors contribute to business cycle convergence? Besides well known factors such as trade integration or factor mobility, one factor could be the synchronized consumption of private households in EMU member countries. Synchronized consumption can in turn be influenced by similar private (finan- cial) investment strategies, leading to similar returns and consumption out of financial wealth. Financial wealth of private households has grown substantially in recent years. In Western Europe, financial wealth amounts for over 150 % of GDP, and the estimation of the annual growth rate of financial wealth is 4.2 % (2002-2006) (Uni Credit Group, 2007). Further growth is expected. The growing importance of financial wealth implies that investment deci- sions have a growing influence on income, the standard of living – and therefore also on consumption. Investment strategies are usually assumed to be rational, 1 1 For a start I will assume rationality of investment decisions although it is known that investors do not necessarily behave rational. Jennifer Schneider - 978-3-653-01915-5 Downloaded from PubFactory at 01/11/2019 11:08:42AM via free access