Demographic transition and asset prices: Evidence from developing countries

• Author: Bhupal Singh
• DOI: http://doi.org/10.1111/infi.12138
• Date: 01 May 2019
• Published date: 01 May 2019

53

International Finance. 2019;22:53–69. wileyonlinelibrary.com/journal/infi © 2018 John Wiley & Sons Ltd

DOI: 10.1111/infi.12138

ORIGINAL MANUSCRIPT

Demographic transition and asset prices: Evidence

from developing countries

Bhupal Singh

Monetary Policy Department, Reserve

Bank of India, Central Office, Mumbai,

India

Correspondence

Bhupal Singh, Monetary Policy

Department, Reserve Bank of India,

Central Office, 24th floor, Shahid Bhagat

Singh Road, Fort, Mumbai, 400051 India.

Email: bhupalsingh1@gmail.com

Abstract

This paper examines the effects of demography on asset

prices in developing countries, which has remained largely

an unexplored area. Using panel data estimators for 25

countries, we find evidence of significant positive impact of

working age population on real housing and stock prices,

buttressing the intuition of the life cycle theory. Contrary to

the evidence for advanced countries, we do not find support

for negative housing wealth effect of ageing due to factors

such as lack of state-funded health and old age safety nets,

reliance on family for social insurance, and strong bequeath

motives rooted in the social configuration. Results also

suggest that as developing countries attain a peak workforce

participation rate over the next two decades, real stock and

housing prices would cumulatively increase 4–7 percentage

points, with concomitant implications for domestic savings,

consumption, aggregate demand and, thus, for the conduct

of macroeconomic policies in developing countries.

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INTRODUCTION

A central issue in the debate on the evolution of asset prices is the role played by changing demographic

factors, that is, changes in the working age population and ageing patterns, and their effects on asset

accumulation and decumulation processes. The cornerstone of the relationship between demography

and asset prices is the life-cycle hypothesis, which suggests that individuals or households build up

assets at the initial stage of their working lives and exhaust the stock of assets for consumption during

old age. Assuming a large cohort, the need for savings for retirement may lead to higher demand for

equity, bonds, and housing assets, which may, however, abate after the cohort retires. As regards

developed countries, where the issue of ageing has been widely analysed and debated, it is generally

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SINGH

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accepted that sizeable gains observed in housing and stock prices during the 1980s and 1990s can be

partially ascribed to demographic factors and the forecast of significant decline in asset prices in the

coming decades to the ageing population (e.g. Abel, 2001; Mankiw & Weil, 1989). Among

academicians, researchers, and analysts, there seems to be a consensus that demographic factors

influencemacroeconomic variables such as aggregatedemand, savings, budget deficits,and asset prices.

In sharp contrast to population ageing observed in the developed world with expectations of faster

ageing in the future and negative spillover on asset prices, developing countries are placed in a

relatively advantageous phase of their demographic curve and are expected to experience sustained

demand and appreciation of asset holdings similar to those witnessed by developed countries at the start

of the 1980s. The demographic bulge or potential dividend for the underdeveloped and developing

economies is expected to be significant until 2050, which in conjunction with rising labour

participation rate, declining dependency ratio, and rising working age, indicates a sustained rise in

savings and demand for assets. Given that the working age population favourably affects asset prices,

the developing world could see a significant positive impact of shifts in demography on asset prices,

which should form an important input for the formulation of monetary and macroeconomic policies. It

is argued that a decline in the total dependency ratio should enable developing economies to hold their

savings and investment rates above the rest of the world.

The research exploring the relationship between demographic changes and asset prices was largely

motivated by the ‘baby boomers’and subsequently the fears of ‘an ageing population’in developed

countries, whereas it has remained an uncharted territory for developing countries despite significant

demographic changes that have occurred during the last two decades. The central hypothesis of this

paper is whether the intuition of the life-cycle models that asset prices are positively affected by the

working age population and the share of ‘prime savers’in the population and negatively by the higher

dependency ratio, holds true. We test the hypothesis for a wide cross section of 25 emerging market and

developing economies (EMDEs). The analysis may help in enhancing our understanding of the role

played by demographic transition in causing movement in asset prices and their relevance for

macroeconomic policy. We contribute by way of providing an analytical framework to understand the

implications of demographic changes in developing countries. Two important findings that may have

far-reaching policy implications are: (i) a significant positive impact of working age population and

‘peak savers’on assets prices and (ii) in contrast to advanced economies (AEs), a lack of a significant

negative effect of the fraction of retirees on asset prices. Juxtaposed with the inflexion in the workforce

participation rate in developing countries expected during the next two decades, these may lead to

significant wealth effects, which will have important implications for savings, asset accumulation, and

consumption demand.

The remainder of this paper is organized as follows. Section 2 explores the theory and empirical

literature and section 3 presents a simple model to demonstrate the linkage between demography and

asset prices and discusses data issues and the variable choices. Section 4 provides empirical estimates

based on various panel data estimators. Section 5 offers concluding remarks, summarizing main

results, and providing some policy recommendations.

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LITERATURE

The theoretical link between asset prices and demography can be traced back to the life-cycle

hypothesis/permanent income hypothesis (Ando & Modigliani, 1963; Friedman, 1957; Modigliani &

Brumberg, 1954). According to these hypotheses, consumption-saving decisions of households vary

with age. The simple analytical framework in which effects of demography on asset prices can be