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This paper tries to empirically examine the validity of Feldstein-Horioka puzzle in the presence of twin deficits for Pakistan over the period 1976 to 2010 using autoregressive distributed lag (ARDL)-bounds testing approach to cointegration. Our finding reveals a positive association between the current account balance and budget deficit in short-as well as in long-run. Toda- Yamamoto (1995) causality test also supports the existence of twin deficits. We also find a negative relationship between current account balance and investment in short-as well as in long-run. The long-run coefficient of investment is -0.75 which implies a high degree of capital mobility by rejecting the Feldstein-Horioka puzzle in case of Pakistan. However, the short-run coefficient of investment is negative but less than one (i.e. -0.46) which provides support for the moderate validity of Feldstein-Horioka puzzle but only in the short-run.
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Introduction
Feldstein and Horioka (1980) find that changes in domestic investment are very sensitive to changes in domestic savings for OECD countries, which has launched a debate regarding the degree of financial integration and financial openness within the Industrialized Countries (Ho, 2003). A positive link between domestic investment relative of gross nation product (GNP) and domestic savings relative to GNP is interpreted as measure of international capital mobility. Dooley et al. (1987) and Feldstein and Bachetta (1989) and generally confirms the Feldstein-Horioka' s findings of close associations between domestic savings and investment for industrial as well as developing countries. The results of Feldstein-Horioka' s study showed that the saving retention coefficient, which measure the level of capital mobility in 2 1 member states of the Organization for Economic Cooperation and Development (OECD) was between 0.87 and 0.91, which proves relatively low capital mobility in these countries (Misztal, 2011). These results imply that 90 percent of savings in OECD member countries are used to finance domestic investment. Some evidence also supports a strong correlation between domestic savings and investment across OECD countries over time, indicating the implications of capital immobility which coins the Feldstein-Horioka puzzle (Ho, 2003). The of Feldstein-Horioka' s (1980) research findings, which are contrary to economic theory, have to be referred to as "the mother of all puzzles" (Obsfeld and Rogoff, 2000, p. 9).
The other puzzle is associated with...