Abstract
What relationship between domestic and foreign variables could explain the observed high correlation between domestic savings and investment in OECD countries with perfect capital mobility? Is such an explanation empirically supportable? This paper constructs a stochastic continuous‐time optimizing model of a small open country. It finds the formula for the implied theoretical correlation between domestic savings and investment—of interest in its own right—and calibrates the model using regression coefficients and stock market data from the US and Canada. The model accounts quite well for the observed investment‐savings correlation, even in the presence of perfect capital mobility.
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