Allocation Puzzle Research Articles

Financial Development and the Capital Flow Allocation Puzzle in Developing Asia

ABSTRACT Using a panel regression approach across 13 developing Asian economies from 1996Q1 to 2019Q4, this paper examines the extent of financial development as a transmission channel for mediating the “allocation puzzle” in capital flows. This puzzle pertains to why capital seems to flow to economies with lower rather than higher productivity growth. We find that while portfolio equity and debt investment flows are negatively related to total factor productivity (TFP) in developing Asia, thereby contradicting the predictions of traditional neoclassical growth models, financial development significantly mitigates this effect. This is particularly the case at earlier stages of financial development and convergence towards a frontier. For foreign direct investment, although we find that there is no direct allocation puzzle in developing Asia, financial development can hamper the stimulatory effect of TFP for highly financially developed economies given diminishing marginal returns.

Performance and efficiency in leaf transport: unveiling the task allocation puzzle in Acromyrmex subterraneus

Performance and efficiency in leaf transport: unveiling the task allocation puzzle in Acromyrmex subterraneus

Private capital flows and productivity in Sub-Saharan Africa: does the capital allocation puzzle matter?

ABSTRACT The puzzling relationship between foreign private capital flows and productivity remains unresolved. We attempt to resolve the puzzle by extending the literature to investigate the effects of the flows across heterogeneous recipient sectors, using a unique hand-collected database of 18 African countries for 2006–2015. We uncover a new interesting finding that the effects of the flows on productivity growth depend on recipient sectors. The results suggest that the negative relationship between foreign private capital flows and economic growth documented in the existing literature, particularly in developing countries, is related to the fact that most of the flows went into sectors, such as extractives and infrastructure, which have less potential for productivity growth. Overall, our findings suggest that the capital allocation puzzle is a sectoral capital allocation puzzle.

TRADING AMBIGUITY: A TALE OF TWO HETEROGENEITIES

AbstractWe consider markets with heterogeneously ambiguous assets and heterogeneously ambiguity‐averse investors whose preferences are a parsimonious extension of the mean–variance framework. We study portfolio choice and trade upon arrival of public information, and show systematic departures from the predictions of standard theory, that occur in the direction of empirical regularities. In particular, our theory speaks to several phenomena in a unified fashion: the asset allocation puzzle, the observation that earnings announcements are followed by significant trading volume with small price change, and that increases in uncertainty are positively associated with increased trading activity and portfolio rebalancing toward safer assets.

Japan and the allocation puzzle in an aging world

Capital that flows from rich to poor countries can be important in equalizing living standards across countries. Various factors, however, contribute to the Lucas Paradox and the mixed empirical evidence on the direction of capital flows. Differences in fundamentals, or simply TFPs, international financial market imperfections, differential demographic aging across regions of the world, or fiscal institutions affect the dynamics of capital flows. This paper builds a general equilibrium model of the world economy under imperfect capital mobility, populated by overlapping generations of individuals in three regions: the High-income (HI), Middle-income (MI) regions and Japan. We show that both TFP and aging are important factors to explain capital flows from the MI region to the HI region in the future and that Japan will turn a net borrower in mid-century in a process where the MI region further accumulates its external wealth. An alternative transition path in which the MI region exhibits catch-up in the expansion of the pension system and the TFP growth throughout the century shows significant effects on the predicted external wealth position of Japan.

On the allocation puzzle and capital flows: Evidence from foreign direct investment and real sector growth in Africa

AbstractThis paper takes a new dimension on the foreign direct investment (FDI)–growth nexus through the lens of the allocation puzzle. We examine how the influx of FDI affects the broader economy through its impact on real economic sectors in a panel of 42 Sub‐Saharan African (SSA) countries over 1980–2017. Using a dynamic panel model and decomposing the real sector into its parts, we test for the possibility of a two‐way bi‐directional relationship between growth in agriculture, manufacturing, industry and service value additions, and FDI. There is no evidence of an allocation puzzle at the level of the real sector and the components parts, which suggests that SSA countries with relatively high growth in the real sector will attract more FDI. While the effect of FDI on the real sector is positive at the disaggregated level, there is a positive bi‐directional effect between FDI and growths in manufacturing, industry and service value additions. The results are robust to key determinants of the growth–FDI nexus.

Financial Development and Capital Flows: Appraisal of the "Allocation Puzzle" By Schumpeterian Growth

Financial Development and Capital Flows: Appraisal of the "Allocation Puzzle" By Schumpeterian Growth

International capital flows in club of convergence

PurposeThe paper analyzes the pattern of international capital flows, accounting for the convergence on economic growth.Design/methodology/approachThe paper employs an empirical analysis combined with a theoretical model. The evidence is based on a cross-section regression over a sample of 172 economies. And the model is an open multi-country overlapping generation (OLG) economy.FindingsThe empirical evidence records that the pattern of international capital flows in the club of convergence can diverge from the pattern in the club of unconvergence. A higher productivity growth rate is associated with more net capital inflows in the club of convergence but less net capital inflows in the club of unconvergence. The theory shows that proximity to world technology frontier can explain the divergence of capital flows.Research limitations/implicationsThe result can account for controversies between theories on the cross-border capital flows: allocation puzzle, up-hill capital flows and neoclassical growth model.Originality/valueThe paper combines both the empirical analysis with the theoretical model construction to account for the role of convergence of economic growth on determining the pattern of international capital flows.

Savings Wedge, Productivity Growth, and International Capital Flows

On one small open OLG economy, the productivity growth determines both the in- vestment through marginal product of capital and the savings through endogenous financial friction modeled as the capital income taxation. Therefore, the over-time fluctuation of international capital flows is shaped by the changes of productivity growth. The empirical evidences on one panel sample of 180 economies over 1980- 2013 confirm the endogeneity of financial friction as one mechanism underlying the impact of productivity growth on net total capital inflows. Furthermore, the combination of theory and evidences reveals that, for capital flows, the implication of Neo-Classical growth model works on the investment side, while the allocation puzzle applies on the saving side.

Exploring the causal relationships and allocation puzzle between portfolio investments and real sector growth in Sub-Saharan Africa

This study explores the causal dynamics and allocation puzzles between real sector growth and portfolio investments (equity and private debt) in Sub Saharan (SSA). We use growth in manufacturing, industry, agriculture, and services to capture the real sector and employ the two-step dynamic systems GMM model to establish our empirical relationships over the period 1980–2017. We found no evidence in support of the puzzle at the overall level of the real sector and portfolio investments. However, at a decomposed level, we established a bi-directional relationship of a positive association between debt flows and growth in agriculture and services, with no evidence of an allocation puzzle. Though we found a bi-directional association between debt and industrial growth, the association was detrimental in both directions. Finally, the study established a two-way inverse causality between equity flows and manufacturing growth. The paper provides a strong foundation for an additional source of financing, especially for the growth of the service and agriculture sectors. The findings also indicate complementary reactions between real sector growth and portfolio investments in SSA.

The Capital Matthew Effect

This study shows that technological specialization is the primary driver of long-term international capital flows. The underlying mechanism comprises the two faces of capital scarcity: although a shortage of capital currently generates a higher marginal product, it also makes a country incline toward capital-saving technology. Therefore, in equilibrium, the rate of capital returns is jointly determined by a convergence effect from diminishing return and an opposing divergence effect from directed technological change. If the elasticity of substitution between labor and capital is sufficiently high, then initially capital-rich countries will favor a capital-biased technology and continuously import capital from capital-poor countries that develop a labor-biased technology. I name this anti-convergence force on capital allocation as the capital Matthew effect. With this perspective, we can rationalize many related international finance puzzles, such as the Lucas paradox, global imbalance, and the allocation puzzle.

Non-linear pattern of international capital flows

In a two-country OLG model with interest rate wedges capturing financial frictions, international capital flows can follow a non-linear pattern, depicted as a U-shaped curve, by first decreasing and then increasing in growth. The turning point of the curve is determined by the world average growth rate and these interest rate wedges. The model developed in this paper can reconcile different theories (i.e, the implications of the neoclassical growth model, up-hill capital flows, and the allocation puzzle) on the pattern of international capital flows.

Demographics and the Evolution of Global Imbalances

The age distribution evolves asymmetrically across countries, influencing relative saving rates and labor supply. Emerging economies experienced faster increases in working age shares than advanced economies did. Using a dynamic, multicountry model I quantify the effect of demographic changes on trade imbalances across 28 countries since 1970. Counterfactually holding demographics constant reduces net exports in emerging economies and boosts them in advanced economies. On average, a one percentage point increase in a country’s working age share, relative to the world, increases its ratio of net exports to GDP by one-third of a percentage point. These findings alleviate the allocation puzzle.

Demographics and the Evolution of Trade Imbalances

The age distribution evolves asymmetrically across countries, influencing relative saving rates and labor supply. Using a dynamic, multicountry trade model I quantify how demographic changes affected trade imbalances across 28 countries since 1970. Counterfactually holding demographics constant reduces net exports in emerging economies that experienced rising working age shares, and boosts them in advanced economies that experienced flatter, or declining, working age shares. This helps alleviate the allocation puzzle. On average, a one percentage point increase in a country's working age share, relative to the world, increased its ratio of net exports to GDP by one-third of a percentage point.

Trading Ambiguity: A Tale of Two Heterogeneities

We consider financial markets with heterogeneously ambiguous assets and heterogeneously ambiguity averse investors. Investors' preferences, a version of the smooth ambiguity model, are a parsimonious extension of the standard mean-variance framework. We consider, in a unified setting, portfolio choice, and trade upon arrival of public information, and show, in both cases, there are systematic departures from the predictions of standard theory. These departures are of significance as they occur in the direction of empirical regularities that belie the standard theory. In particular, our theory speaks to several puzzling phenomena in a unified fashion: the asset allocation puzzle, the observation that earnings announcements are often followed by significant trading volume with small price change, and that increases in uncertainty are positively associated with increased trading activity and portfolio rebalancing toward safer assets by individual (retail) investors.

Capital Flows Across Developing Countries: Is There an Allocation Puzzle?

Foreign direct investment inflows are positively related to economic growth across developing countries — but so are savings in excess of investment. This paper develops an explanation for these known empirical findings by focusing on the limited availability of consumer credit in developing countries, together with general equilibrium effects. In the model, fast-growing developing countries scale up their holdings of debt assets, which creates net capital outflows — despite inflows of foreign direct investment — and reduces the world interest rate. Slow-growing developing countries reduce their holdings of debt assets in response, which creates net capital inflows despite outflows of foreign direct investment.

A Review of the Internal Capital Allocation Literature: Piecing Together the Capital Allocation Puzzle

Allocating internal financial capital represents a key task for managers of multidivisional corporations. This has led to a wealth of research and theorizing about capital allocation and whether or not managers allocate capital successfully. However, capital allocation research has diverged in a number of directions that reflect different and often incompatible perspectives, underlying frameworks, and outcomes. The result is a puzzle, wherein scholars have found little consistent substantive relation between capital allocation, business unit characteristics, and firm performance. Through our review, we seek to bring clarity to this puzzle by identifying problems in the literature and by offering a solution. We suggest problems in the literature stem from the disparate approaches scholars have taken when studying capital allocation, including assessments of what constitutes and prevents successful allocation. We begin by organizing these approaches into a framework that highlights key allocation strategies and the primary impediments to allocation success that scholars have used to build their models. We then suggest that managers may employ a number of allocation strategies and that scholars need to recognize that not all corporate managers employ the same strategy. We contend that a resurgence of obtrusive, qualitative, and multilevel studies may help explain why managers select one strategy over another. Ultimately, we recommend scholars delve into the black box of organizations to truly understand capital allocation.

Asset pricing puzzles in an OLG economy with generalized preference

AbstractWe seek to explain a number of asset pricing anomalies – the equity premium puzzle, the risk‐free rate puzzle, and portfolio allocation puzzle – in a parsimonious overlapping generations (OLG) model with two key features: borrowing constraint and Epstein–Zin–Weil (1989) preference. The model goes a long way towards the resolution of these puzzles, and is able to simultaneously match asset pricing moments and individual portfolio decisions using reasonable values of parameters governing behavior. We find that the main driver of savings behavior, equity returns, and asset allocation is the relative difference between the two parameters: the level of relative risk aversion and the inverse of the elasticity of substitution.

Patterns of International Capital Flows and Their Implications for Developing Countries

According to a standard economic theory, capital should flow from rich capitalabundant countries to poor capital-scarce countries. However, a reverse pattern has prevailed in the world economy. This is the so-called Lucas paradox. In addition, it has been shown that counterintuitively there is negative correlation between capital inflow and productivity growth across developing countries. This is the so-called allocation puzzle. This survey attempts to shed light on the following questions: 1) What are the patterns of international capital flows in the world economy? 2) What are the most plausible explanations for these patterns? 3) What are the possible implications of these developments for developing countries?

Non-Traded Goods, Structural Change, and Capital Flows to Developing Countries

We analyze the quantitative impact of the non-tradable sector and structural change on international capital flows. We argue that the allocation puzzle (Gourinchas and Jeanne (2013)) reflects the difference in the magnitudes rather than the direction of net capital flows predicted by the one sector model and those observed in the data. We show that the introduction of a non-tradable sector can reconcile much of the differences between the predictions of the model and the empirical observations, and account for as much as 54% of the allocation puzzle. Complementarity in consumption between tradable and non-tradable goods, as well as structural change, as measured by the movement of labor from agriculture and manufactures (tradable) to services (non-tradable), play a central role in accounting for the relatively low magnitudes of capital flows observed in the data.