Capital Controls, Pension Funds, and Foreign Assets - Evidence From Iceland
Abstract: Capital controls in Iceland were implemented in 2008, following the collapse of the three largest Icelandic banks and the systematic crisis that subsequently followed. The controls on outflow of capital affect various entities within the economy, one of them being pension funds. This paper examines the cost of capital controls to pension funds due to foreign investment prohibition. Cost factors regarding decreased returns and increased volatility in a period of capital controls are investigated using a panel fixed effects model. The results from the empirical analysis indicate that in a period of capital controls, Icelandic pension funds experience higher returns by having lower fraction of foreign assets out of total assets. Furthermore, relative volatility seems to increase as the fraction of foreign assets grows. Despite the finding that Icelandic pension funds do not seem to bear direct costs of capital controls the pension funds hold onto their foreign assets. In conclusion, gains from retaining foreign assets are merely considered to be in terms of increased risk diversification and hedging against macroeconomic uncertainty once lifting of capital controls will take place.
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