Validity of F-H hypothesis in small isolated island economy: an application of the combined cointegration approach^*

Abstract

This study aims to investigate the Feldstein-Horioka hypothesis for North Cyprus using ARDL bounds test for cointegration for period 1983–2012. The robustness of the ARDL was done by the newly developed Bayer-Hanck (2013) combined cointegration test. The empirical results revealed that both savings and investments are cointegrated, while the findings from the long-run and short-run analysis validate the F-H hypothesis suggesting, that North Cyprus have closed-economy in which domestic investments are related to domestic savings. Furthermore, investment converges to its long-run equilibrium position by 43.95% speed of adjustments using channel of savings. Finally, the result of Granger causality under the framework of ECM suggests that savings cause investment in short-run, long-run and both joint short-run and long-run causality.

Keywords:

• Feldstein-Horioka
• Bayer-Hanck combined cointegration test
• investment
• savings

Jel Codes:

• C01
• E21
• E22

Acknowledgements

The authors would like to thank the anonymous reviewers for suggestions that substantially improved the article.

Notes

* Accepted by Yue Ma upon recommendation by Junbo Wang

1. Data on these variables obtained from the State Planning Organization of North Cyprus http://www.devplan.org/. Data covered the period of 1983–2012.

2. See Bayer and Hanck (2013) for more details.