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Portfolio choice of financial investors and European business cycle convergence: a panel analysis for EU countries

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Abstract

We investigate the linkage between business cycle convergence and financial portfolio choice for a panel of 18 EU countries. We construct an index of similarity of financial portfolios which we then put into context with the view that “the financial world” has an impact on business cycles and contributes to business cycle convergence via the consumption-wealth linkage. The model which guides our analysis is the International Asset Pricing Model (IAPM). Portfolios of the 18 EU countries investigated by us turn out to become more similar over time. According to our fixed effects GMM TSLS estimations, similar portfolios contribute to a convergence of business cycles—via a convergence of consumption cycles. This turns out to be especially true for country-pairs that include euro area non-member countries and, thus, have quite different income and wealth structures.

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Notes

  1. Solnik (1974) in his intertemporal model differentiates between a hedged stock market portfolio and a risk free bond portfolio. The bond portfolio is only riskless with regard to its beta, not with regard to exchange rate risk. These two risky assets are summarized in this paper to the world market portfolio. The risk free asset is our usual risk free asset with a beta of 0 and no exchange rate risk.

  2. Our final sample ranges from 2001 to 2006 although in same cases lagged variables, the latest from the year 2000, are used.

  3. Exact data availability is mentioned in the text on a case-by-case basis in the respective sections.

  4. This technique is based on a polynomial fit to the data with a weighted Least-squares method, according to which large residuals have less weight as small residuals to achieve higher variations not distorting the results. This is the main advantage of this visualization as opposed to the OLS procedure which is quite sensitive to outliers.

  5. Results are available on request.

  6. We would like to stress that a correlation of the endogenous variables with the error term is not a necessary precondition to use instrumental variable approaches. Nevertheless, it is a sufficient precondition.

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Authors and Affiliations

  1. DIW Berlin, IZA Bonn, and Chair for Macroeconomics, Department of Economics, University of Duisburg-Essen, Campus Essen, 45117, Essen, Germany

    Ansgar Belke

  2. University of Hohenheim, Stuttgart, Germany

    Jennifer Schneider

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  1. Ansgar Belke
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  2. Jennifer Schneider
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Correspondence to Ansgar Belke.

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Belke, A., Schneider, J. Portfolio choice of financial investors and European business cycle convergence: a panel analysis for EU countries. Empirica 40, 175–196 (2013). https://doi.org/10.1007/s10663-011-9181-4

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