Did Adhering to the Gold Standard

Federal Reserve Bank of Chicago

Reduce the Cost of Capital?

Ron Alquist and Benjamin Chabot

November 22, 2010

WP 2010-13
 DidAdheringtotheGoldStandardReducetheCostofCapital?

RonAlquist
BankofCanada

BenjaminChabot
FederalReserveBankofChicagoandNBER

Abstract:AcommonlycitedbenefitofthepreͲWorldWarOnegoldstandardisthatitreduced
thecostofinternationalborrowingbysignalingacountry’’scommitmenttofinancialprobity.
Usinganewlyconstructeddatasetthatconsistsofmorethan55,000monthlysovereignbond
returns,wetestifgoldͲstandardadherencewasnegativelycorrelatedwiththecostofcapital.
ConditionalonUKriskfactors,wefindnoevidencethatthebondsissuedbycountriesoffgold
earnedsystematicallyhigherexcessreturnsthanthebondsissuedbycountriesongold.Our
resultsarerobusttoallowingbetastodifferacrossbondsissuedbycountriesoffͲandonͲgold;
toincludingproxiesthatcapturetheeffectoffiscal,monetary,andtradeshocksonthe
commitmenttogold;andtocontrollingfortheeffectofmembershipintheBritishEmpire.



Keywords:Goldstandard;sovereignborrowingcosts;countryriskpremium.

JELclassifications:F33;G15;N23.


Acknowledgements:WethankJeremyAtack,ChristianeBaumeister,CharlesCalomiris,WeiDong,
RobertLafrance,KimOosterlinck,GregorSmith,LindaTesar,andMarcWeidenmierforcommentsand
suggestions.Wealsothankseminarparticipantsatthe2006NBERSummerInstitute,theCenterfor
FinancialStudiesSummerSchool,andthe2008CanadianEconomicAssociationmeetingsforhelpful
comments.MaggieJimandRobPrechtprovidedfirstͲrateresearchassistance.

Theviewsexpressedinthepaperrepresenttheauthors’’ownandshouldnotbeattributedtoFederal
ReserveBankofChicago,TheFederalReserveSystemortheBankofCanada.

CorrespondingAuthor:RonAlquist,BankofCanada,234WellingtonStreet,Ottawa,ONK1A0G9.
Email:ralquist@bankofcanada.ca.
1.Introduction
Thegoldstandardbefore1914isgenerallyconsideredtobeaprimeexampleofanexchange
rateregime’’sabilitytoconfercredibilityonacountry’’smacroeconomicpolicy.The““goodͲ
housekeepingsealofapproval””interpretationofthegoldstandardpostulatesthatgold
convertibilityensuredthatthegovernmentactedconsistentlyovertime,sothatadherenceto
goldservedasasignaloffinancialprobity.Accordingtothisview,countriesthatalways
maintainedconvertibilityorsuspendeditonlyduringwidelyagreedͲuponcircumstances(such
aswar)shouldhavebeenrewardedwithlowerborrowingcosts.
Despiteitssharpprediction,economistshavereachedconflictingconclusionsaboutthe
effectofgoldͲstandardadherenceonsovereignborrowingcosts.Intheirseminalstudy,Bordo
andRockoff(1996)comparethecouponyields(couponͲpriceratios)ofsovereignbondsissued
byninecountriesandfindsubstantialcrossͲcountryvariationinpreͲWorldWarOneyields.
Theyattributetheyielddifferencestodifferingcommitmenttogold.Thesefindingsare
consistentwiththecountrystudiesofMartinͲAcena(1993)andSussmanandYafeh(2000),and
wereconfirmedinalargercrossͲsectionofcountriesbyObstfeldandTaylor(2003).The
reductioninborrowingcostsassociatedwithadheringtogoldisestimatedtobeabout30Ͳ40
basispointsperyear(BordoandRockoff1996;andObstfeldandTaylor2003)
Ontheotherhand,FergusonandSchularick(2006)findnoevidencethatthecapital
marketrewardedgoldͲstandardadherenceandconcludethatmembershipintheBritishEmpire
waskeytoreducingborrowingcosts.ClemensandWilliamson(2004)examinecapitalflows
ratherthanbondyieldsandpresentevidencethatgoldͲstandardadherencewasonly
marginallyimportantcomparedtofundamentaldeterminantsofcapitalproductivity.Flandreau
andZumer(2004)concludethatadheringtothegoldstandardhadanegligibleinfluenceon
couponyields,conditionalonothercovariatesintendedtocapturetheeffectoffiscaland
monetarypolicyonsovereignborrowingcosts.Theyarguethatinternationallendersfocused
onvariablesthatforecastacountry'sabilitytorepayitsexternaldebtandthattheseforecasts
assignedlittleweighttotheexchangeͲrateregime.MitchenerandWeidenmier(2009)compare
withinͲcountrycouponyieldsofbondswithandwithoutgoldclausesandconcludethatthe
internationalcapitalmarketplacedlittleweightongoldͲstandardadherence.

2
 Thecruxoftheempiricaldisagreementcanbetracedtodifferencesintheavailable
data.Incontrasttotoday,sovereignborrowersduringthegoldͲstandarderaissueddebtwith
differentmaturitiesandatinfrequentintervals.Asaresult,atypical19thcenturysovereign
borrowerhadonlyahandfulofmaturitiestradingatanygiventime,makingitimpossibleto
compareacrossͲsectionofbondswithmatchedmaturities.Tocomplicatemattersfurther,
mostcountriesissuedbondswithstochasticmaturityschedulesthatmakeitimpossibleto
computeyieldͲtoͲmaturityandpreventdirectcomparisonsofyieldsacrosscountries.
Datalimitationshaveforcedpastresearcherstoinferborrowingcostsbycomparingthe
couponyieldofbondsatdifferentpointsoftheyieldcurve.Typically,asinglerepresentative
bondischosenforeachcountrybasedonavailability,liquidity,ortheamountoutstanding.The
couponyieldisobservedforaslongaspossible,afterwhichanotherrepresentativebondis
chosen.Becausebondswiththesame(unobserved)discountratecanhaveverydifferent
couponyieldsattributabletodifferencesintimetomaturityorcouponamounts,thereisno
guaranteethattheobserveddifferencesinthecouponyieldofbondswithdifferentmaturities
actuallyareduetodifferencesintheexchangeͲrateregimeratherthanthetermstructureof
theborrower’’sexternaldebt.Inlightofthesechallenges,itisnotsurprisingthatauthorsusing
differentrepresentativebondshavearrivedatconflictingconclusions.
Becauseitisunlikelythataconsensuscanbereachedwiththeexistingdata,we
proposeatestofthegoodͲhousekeepinghypothesisbasedonanewandmuchlargersample
ofrealizedholdingͲperiodreturns.Withover55,000bondreturns,thesizeofournewdataset
representsanalmost40ͲfoldincreaseinthecrossͲsectionofavailablebondprices.1Ourdata
setconsistsofeveryregularlyquotedsovereignbondfromtheofficialquotationlistofthe
LondonStockExchangebetween1870and1907.Weavoidthedifficultyofinferringdiscount
ratesfromthecouponyieldofbondswithdifferenttimestomaturitybycollectingmonthly
pricedataandcalculatingrealizedholdingͲperiodreturns.UsingholdingͲperiodreturnsisanew
waytomeasurethecostofcapitalintestsofthegoodͲhousekeepinghypothesis,butitisvery

1
Toourknowledge,thetwolargestprevioussamplesof19thcenturysovereignbondpricesarethedatasets
availablefromGlobalFinancialData(GFD)usedbyObstfeldandTaylor(2003)andtheoneconstructedby
FergusonandSchularick(2006).GFDcontains892annualobservationswhileFergusonandSchularick’’sdataset
contains1461annualobservations.

3
commoninassetͲpricingteststhattrytoaccountforcrossͲsectionaldifferencesinexpected
bondreturnstoexͲanteobservablecharacteristics.
Wefindthatadherencetothegoldstandarddidnotreducethecostofcapital.Acrossa
varietyofspecificationsandsamples,thereisnosystematiclinkbetweenacountryadheringto
goldandtheriskͲadjustedreturnofitssovereigndebt.ConditionalonBritishriskfactors,the
returnsofbondsissuedbycountriesonandoffgoldarestatisticallyindistinguishablefromone
another.Wealsoexaminealmost20,000bondreturnsfromcountriesthatswitchtheir
exchangerateregimeanddonotfindsystematicdifferencesinthesensitivityofthereturnsto
pervasiveriskfactorsacrossregimes.OurfindingscastdoubtuponthegoodͲhousekeeping
hypothesisandsupporttheconclusionreachedbyFlandreauandZumer(2004)thatgoldͲ
standardadherencedidnothaveaneconomicallyimportanteffectonthecostofcapital.
Section2discussesthelogicofthegoldstandardasarepeatedgame.Section3
examinesthecloseparallelsbetweentestsofthegoodͲhousekeepinghypothesisandassetͲ
pricingtestsdesignedtodetectdifferencesinmeanreturnsacrosssecurities.Section4
describestheempiricalspecification,methods,anddataweusetotestthegoodͲhousekeeping
hypothesis.Section5reportstheresultsandasetofrobustnesstests.

2.TheGoldStandardasaRepeatedGame
BordoandKydland(1995)modelthegoldstandardasacrediblecommitmentmechanismthat
evolvedtoovercomethetimeͲinconsistencyproblemassociatedwithinternationalborrowing.
Borrowersandlendersintheinternationalcapitalmarketplayarepeatedgameinwhichthe
governmentchoosesamixofborrowing,taxation,andinflationtominimizethedeadweight
lossforagivenlevelofrevenue.Thegovernment’’sabilitytoprintmoneyandinflateawaythe
nominalvalueofexternaldebtcreatesanincentiveproblemwhenitonlycaresaboutthe
welfareofitsresidents(Bohn1991).Foreignlendersrecognizethedistortedincentivesofthe
borrowingcountryandareunwillingtolendfundswithoutacrediblecommitmentthatthe
governmentwillrepaytherealvalueofitsdebt.
Intherepeatedgame,agovernmentcanovercomethetimeͲinconsistencyproblemby
adoptinganeasyͲtoͲmonitorpolicythatpreventsitfromdevaluingitscurrency.ThegoodͲ

4
housekeepinghypothesispostulatesthatadherencetogoldservedassuchamechanism.The
goldͲstandardequilibriumstrategyconsistsofthegovernmentcommittingtocurrencystability
bystandingreadytoconvertlocalcurrencyintogoldondemand.Inresponse,theinternational
bondmarketrewardsthegovernmentthattiesitscurrencytogoldwithalowcostofcapital.
TheempiricalimplicationofthegoodͲhousekeepinghypothesisisthattheinternationalcapital
marketassignedalowerprice,anddemandedcommensuratelyhigherexpectedreturns,to
bondsissuedbycountriesthatdidnotadheretothegoldstandard.
The““goodͲhousekeeping””repeatedgameequilibriumreliesonthecapitalmarket
collectivelyforgoingcurrentexpectedprofitstopunishgovernmentsthatleftgold.For
example,iftwodifferentcountriesissuebondswithidenticalexpectedcashflows,the
equilibriumpunishmentstrategyrequiresinvestorstoassigndifferentpricesifthecountries
havedifferingcommitmentstogold.Assigningdifferentpricestothesameexpectedcashflow
createsastatisticalarbitrageopportunity.Therefore,therepeatedgameequilibriumrequiresa
collectiveactionmechanismtopreventarbitrageͲseekinginvestorsfrompushingthepricesof
otherwiseidenticaloffͲandonͲgoldbondstogether.Largeinstitutionalinvestorswhowere
bothsufficientlypatienttoplaythepunishmentstrategyandlargeenoughtoinfluence
equilibriumprices,suchastheCouncilofForeignBondholdersandinvestmentbankswho
underwrotebondissues,weregoodcandidatestopunishcountriesthatabandonedthegold
standard.TheavailablearchivalevidencesuggeststhattheCouncilwaseffectiveatboth
organizinglenderswhenborrowersdefaultedandrenegotiatingwithlargeborrowerslike
Argentina,Brazil,andTurkey(MauroandYafeh2003).ThetestofthehypothesisthatoffͲgold
bondsearnedhigherriskͲadjustedreturnsthanonͲgoldbondsisadirectempiricaltestof
whethertheseorganizationsweresufficientlypowerfultopunishcheaters.

3.TestingtheGoodͲHousekeepingHypothesis
ThetheoryproposedbyBordoandKydlandmakesaclearprediction:Countrieswererewarded
withalowdiscountrateiftheymaintaingoldconvertibility.Butbonddiscountratesvaryfor
reasonsotherthanacountry’’sgoldͲstandardadherence,andanytestofthehypothesisneeds
tocontrolforotherdeterminantsofacountry’’sriskpremium.TraditionaltestsofthegoodͲ

5
housekeepinghypothesiscomparethecouponyieldofbondsoffͲandonͲgoldcontrollingfor
otherriskfactorsbyestimatingregressionsthatareverysimilartoassetͲpricingtestsdesigned
todetectcrossͲsectionaldifferencesinreturns,conditionalonotherpervasiveriskfactors.
Indeed,BordoandRockoffwritethattheirempiricalspecificationofthegoodͲhousekeeping
hypothesisis““inspiredbythecapitalassetpricingmodel””(BordoandRockoff1996).The
empiricalspecificationsofselectedtestsofthegoodͲhousekeepinghypothesisarereproduced
inTable1.
AllofthesetestsexaminetheeffectofgoldͲstandardadherenceonriskͲadjustedreturn
byformallytestingforashiftintheinterceptሺɷ ൏ Ͳሻofamodelthatcontrolsforother
determinantsofthesovereignriskpremium.Theregressiontestsareformulatedtodetecta
commondifferenceinthemeanriskͲadjustedcouponyieldbetweenonͲandoffͲgoldcountries.
 ThespecificationslistedinTable1areverysimilartofactormodelͲbasedassetpricing
teststhatcrossͲsectionalvariationinexͲanteobservablecharacteristicsgeneratesdifferences
inmeanexcessreturns.2Bothcontrolforriskusingfactormodelsandtestifanobservable
characteristicaffectsriskͲadjustedreturnbyexaminingcrossͲsectionaldifferencesinportfolio
intercepts.TraditionaltestsofthegoodͲhousekeepinghypothesisandfactormodelbasedtests
arethusfullyconsistentwitheachanother.
HoldingͲperiodreturnsareanaturalwaytomeasuringborrowingcostswhenthe
numberofbondsistoosmalltoidentifytheyieldcurveorcomparecouponyieldsatmatched
maturities.LikecouponͲyield,holdingͲperiodreturnsarecorrelatedwiththeunobservable
discountrateandcanbeusedtoinferdifferencesinexpectedreturns(Campbell1995).Unlike
couponͲyield,holdingͲperiodreturnsincludeboththeexpectedcouponyieldandtheexpected
capitalgain.Manysovereignbondsduringthelate19thcenturytradedwellaboveorbelowpar,
andrationalinvestorssurelyexpectedcapitallossesorgainswhenpurchasingthesebonds.
Returnstakeaccountoftheseexpectedchanges.

 

2
Forexample,CornellandGreen(1991),FamaandFrench(1993)andEltonetal.(1995)

6
4.EmpiricalMethods

WeusetheholdingͲperiodreturnsofvalueͲweightedcountryportfoliostoaccountforboth
maturitymismatchandembeddedoptions.Foreachcountry,wecomputetheholdingͲperiod
returnonthevalueͲweightedportfolioofbondsoutstanding.IfcountryihasJbonds
outstandingattimet,thereturnofcountryi’’sportfoliois

௃
(1)  ܴ௜௧ ൌ σ௝ୀଵ ‫ݓ‬௜௝௧ ൈ ܴ௜௝௧ 


where‫ݓ‬௜௝௧ isthemarketͲvalueweightofbondjincountryiattimet;ܴ௜௝௧ ൌ ሺܲ௜௝௧ ൅
‫ܥ‬௜௝௧ ሻȀܲ௜௝௧ିଵ isthegrossholdingͲperiodreturnofbondjincountryI;ܲ௜௝௧ isthepriceofthe
bondattimet;and‫ܥ‬௜௝௧ isthecouponpayment(ifany)betweentimetͲ1andtimet.Thereturn
andamountoutstandingofallofthebondsisdirectlyobservable,asiswhetherabondiscalled
andredeemedatpar(oranyothervalue).
WefocusonholdingͲperiodreturnsratherthancouponyieldbecausereturnsaccount
formaturitymismatchcausedbybothdifferencesinmaturityandembeddedoptions.Many
sovereignbondscontainedstochasticmaturitiesduetoclauses,suchasredemptionoptions
thatgavetheborrowertherighttorepaythebondatparbetweenpreͲspecifieddates;sinking
fundsthatcommittedtheborrowertoredeemannuallyafixedportionofthedebtoutstanding;
orlotteriesinwhichtheissuercontractedtoredeemafixedportionoftheoriginalissueatpar
viaannualdrawings.Iftwocountrieshadbondsthatmaturedatdifferentdates,differencesin
observedcouponͲyieldcouldbeduetoobservingdifferentpointsonidenticalyieldcurves
(termstructures)ratherthanactualdifferencesinyieldcurves.Ifthebondalsohasastochastic
maturitydate,themeasurementerrorbecomesmoreacute.
TheexistenceofembeddedoptionsbiasesthecouponͲyieldmeasurescommoninthe
goodͲhousekeepingliterature.TheseoptionscreatewhatFlandreauandZumer(2004)call
““conversionrisk””.FlandreauandZumer(2004)controlforconversionriskbycarefullyselecting
bondswithcouponratessuchthattheirconversionoptionthatarelikelytobefaroutͲofͲtheͲ
money.Thisstrategyminimizesthemeasurementerrorproblem,but,atleastwithourLondon

7
sample,comesatthecostofhavingtoexcludemanycountriesthatonlyhavebondswherethe
optionisinorclosetoinͲtheͲmoney.
PreͲpaymentriskisrareinmodernͲdaysovereignbondmarkets,butquitecommonthe
marketsformortgagebackedsecurities,realͲestateinvestmenttrusts,andcorporatebonds.
Studiesthatexaminethereturnsofthesesecuritiesfaceexactlythesameproblemthatweface
inourtestofthegoodͲhousekeepinghypothesis:Doesanobservabletraitexplaindifferencesin
expectedreturn?TheuseofholdingͲperiodreturnsandfactormodelsofthetypethatinspired
BordoandRockoff‘‘sspecificationarecommonlyusedtomeasuredifferencesinriskadjusted
returnsacrossbondportfolioswithdifferentmaturitiesandembeddedoptions.3Thus,using
holdingͲperiodreturnstomeasuresovereignborrowingcostsfacilitatesthecomparisonof
bondswithdifferent,possiblystochastic,maturitiesandtakesaccountofexpectedcapitalgains
andlosses.

4.1.LeveragedPortfolios
WetestthehypothesisthatexpectedreturnsdifferacrossexchangeͲrateregimebyforminga
leveragedportfoliothatmimicsthereturnassociatedwithpurchasingallbondsissuedby
countriesoffgoldandsellingshortallbondsissuedbycountriesongold.4Atthebeginningof
eachholdingperiod,allbondsareassignedeithertoanonͲgoldoroffͲgoldportfolio.Ifa
countryadoptsthegoldstandard,weremovethatcountry’’sbondsfromtheoffͲgoldportfolio
andaddittotheonͲgoldportfolioatthebeginningofthenextholdingperiod,andviceversa.If
thegoodͲhousekeepinghypothesisistrue,theleveragedportfolioshouldearnapositiveriskͲ
adjustedreturn.
Weusecontemporaryandmodernsourcestodateeachcountry’’sgoldͲstandard
adherence.AdetailedlistofthesourcesisreportedinAppendix2.Incaseswhereitisdifficult
todeterminedejureversusdefactoadherencetothegoldstandard,wecodethecountryas

3
BondfactormodelsinthespiritofFamaandFrench(1993)andEltonetal.(1995)typicallyincludemarket,term
structure,anddefaultfactorssimilartoourstockmarket(market),Consol(termstructure)andcorporatebond
(default)factors.ThesemodelsareoftenusedtotestfordifferencesintheriskͲadjustedreturn(alpha)ofbond
portfoliosthathavedifferentmaturitiesandembeddedoptions.
4
Tobeclear,weformulatethetestinthiswaynotbecausewethinka19thcenturyinvestorformedaleveraged
portfolioofsovereignbondsbasedongoldͲstandardadherencebutbecausedoingsoallowsustotestfora
differenceinmeanreturnsacrossthetwoexchangeͲrateregimes.

8
adheringtogoldfromthedejureconvertibilitydate.Inmanycases,weareabletodategoldͲ
standardadherencequiteprecisely,identifyingthemonthandsometimeseventhedayon
whichacountryadoptedorabandonedconvertibility.Inthecaseswherewecanonlyidentify
theyearinwhichacountryadoptedthegoldstandard,wedategoldͲstandardadherencefrom
January1ofthatyear.
ItisimportanttostressthatbecauseofhowwedategoldͲstandardadherence,our
benchmarkregressionsarebiasedtowardfindingevidenceinfavorofthegoodͲhousekeeping
hypothesis.TheLondoncapitalmarketmayhaveanticipatedswitchesingoldͲstandard
adherenceandrepricedbondsinresponsetothechangeinexpectations.Ifthegood
housekeepinghypothesisistrue,thebondsissuedbycountriesoffgoldthatswitchtobeingon
goldexperienceacapitalgainasthemarketrepricestheirbondsatalowerdiscountrate.Ifthe
marketanticipatestheswitchfromofftoon,thereturnsoftheoffgoldportfolioarehigheven
beforethedateofofficialconvertibility.Similarly,thebondsissuedbycountriesongoldthat
switchoffexperienceacapitallossasthemarketrepricestheirbondsatahigherdiscountrate.
Again,ifthemarketanticipatessuchaswitch,thereturnsoftheonͲgoldportfolioareloweven
beforethecountryofficialabandonsconvertibility.Thus,thereturnsoftheoffͲgoldportfolio
arebiasedupwardbecauseofourdatingprocedurewhilethereturnsoftheonͲgoldportfolio
arebiaseddownward.Thetwoeffectsbiasthereturnsoftheleveragedportfolioupward.By
sortingbondsintooffͲandonͲgoldportfoliosandusingthisdatingprocedure,weextendthe
goodͲhousekeepinghypothesiseveryadvantageintheempiricaltest.5

4.2.EmpiricalSpecification
Weformaleveragedportfoliobycomputingthereturnsofaportfoliothatislonginthebonds
issuedbycountriesoffgoldandshortinthebondsissuedbycountriesongold.Ifthetwo
portfolioswereequallyriskyandthemarketpunishedbondsissuedbycountriesoffgold,this
strategywouldhavegeneratedpositiveexcessreturns.

5
Inanearlydraft,wecontrolledforanticipationeffectsbyformingperfectͲforesightportfolios.Weassignedbonds
totheoffͲandonͲgoldportfoliosuptotwoyearsbeforetheactualchangeinstatusoccurred.Ourconclusionthat
goldͲstandardadherencedidnotaffectsovereignborrowingcostsisrobusttothisalternativecodingscheme.
Theseresultsareavailableuponrequest.

9
 Thekeywordsare““equallyrisky””.Investorsduringthelate19thcenturyalmostsurely
demandedcompensationforrisksbeyondthoseembodiedingoldͲstandardadherence.If
exposuretootherriskfactorsdifferedacrossportfolios,differencesinrealizedreturnmaybe
duetoexposuretotheotherrisksandnotexclusivelyduetodifferencesingoldͲstandard
adherence.
Wecontrolforriskwithafactorpricingmodelthatcomparesthereturnofatest
portfoliotothatofasimilarlyriskyportfolioofBritishfinancialassets.Weestimatethe
regression

(2) ܴ௜௧ െ ܴ௙௧ ൌ ߙ௜ ൅ ߚଵ ൫ܴ௖௢௡ǡ௧ െ ܴ௙௧ ൯ ൅ ߚଶ ൫ܴௌெǡ௧ െ ܴ௙௧ ൯ ൅ ߚଷ ൫ܴ஻ெǡ௧ െ ܴ௙௧ ൯ ൅ ߝ௧ 

whereܴ௜௧ isthetimetreturnofportfolioi;ܴ௖௢௡ǡ௧ isthetimetreturnontheUKgovernment
consol;ܴௌெǡ௧ isthereturnonthevalueͲweightedportfolioofallBritishequitiesattimet;and
ܴ஻ெǡ௧ isthevalueͲweightedportfolioofUKcorporatebonds.WeusetheLondonbanker’’sbill
rateasaproxyfortheriskͲfreerateܴ௙௧ .
ߙ௜ iscalledJensen’’salphaafterJensen(1967),whoproposedusingittomeasurea
portfolio’’sreturncontrollingforrisk.Alphameasuresthedifferencebetweenportfolioi’’s
returnandthereturnoftheportfolioofBritishsecuritieswithpercentageweightsߚଵ invested
intheUKgovernmentconsol,ߚଶ investedinthevalueͲweightedUKstockmarketportfolio,ߚଷ 
investedinthevalueͲweightedBritishbondmarketportfolioandͳ െ ߚଵ െ ߚଶ െ ߚଷ investedin
theLondonbanker’’sbill.
Weestimatetheexcessreturnoftheleveragedportfoliowiththeregressionequation:

(3) ܴ௢௙௙ǡ௧ െ ܴ௢௡ǡ௧ ൌ ߙ ൅ ߚ෨ଵ ൫ܴ௖௢௡ǡ௧ െ ܴ௙௧ ൯ ൅ ߚ෨ଶ ൫ܴௌெǡ௧ െ ܴ௙௧ ൯ ൅ ߚ෨ଷ ൫ܴ஻ெǡ௧ െ ܴ௙௧ ൯ ൅ ߝ௧ 

whereߚ෨௞ ൌ ߚ෨௢௙௙ǡ௞ െ ߚ෨௢௡ǡ௞ byconstruction.Thebetasoftheleveragedportfolioinequation(3)
areequaltothedifferenceinthesensitivitiesoftheoffͲgoldandonͲgoldportfoliosto
fluctuationsintheUKriskfactors.AtestofthegoodͲhousekeepinghypothesisamountstothe
testthatalphaisgreaterthanzero.

10
 Anadvantageofthistestisthatitaddressestheproblemthatcountriesdidnotleave
goldrandomly.Ifacountrywantedtoremainongoldbutwasforcedoffduetoanegative
businessͲcycleshock,weneedtodistinguishbetweenexcessreturnsduetoexposureto
businessͲcycleriskandtherepeatedgamepunishment.IfbusinessͲcycleshocksarecorrelated
acrosscountries,UKinvestorscouldhavelegitimatelydemandhigherexpectedreturnsas
compensationforbearinggreaterbusinessͲcyclerisk.Inthiscase,thegoodͲhousekeeping
hypothesiscouldbefalsebutthereturnsofthebondsissuedbycountriesongoldwouldbe
lowerbecausetheywerelessexposedtoBritishbusinessͲcyclerisk.Bycomparingforeign
returnstothiscontrolgroupofsimilarlyriskyUKsecurities,wedisentanglethetwoeffectsand
cantestifinvestorsdemandedapremiumduetogoldͲstandardadherenceorbusinessͲcycle
risk.

4.3.Data
ThesemethodsnecessarilyrequiremonthlyreturndatafromalargecrossͲsectionofsovereign
bonds.WecollectasampleofsovereignandcolonialbondstradingontheLondonStock
Exchangebetween1870and1907.Ourdatasetconsistsofthebidandaskpricesandcoupon
paymentsforeveryforeigngovernmentbondregularlyquotedontheExchange.Thedata
representabroadcrossͲsectionofbondsissuedbycountriesbothonandoffgold(Figure1).
Thepricesaresampledevery28ͲdaysfromtheofficialFridayquotationlistpublishedinthe
MoneyMarketReviewandtheEconomist.6Weusethepriceandcoupondatatocomputea
timeseriesof28ͲdayholdingͲperiodreturnscorrectedforsovereigndefaults.7Appendix1
containsmoreinformationabouttheunderlyingdata.

4.4.SampleofCountries
Inadditiontothechallengesassociatedwithconsistentlymeasuringthesovereigncostof
capitalduringthelate19thcentury,apossibleexplanationforthelackofconsensusamong

6
Theholdingperiodis28ͲdaysbecauseoursourcespublishedtheLondonStockExchangepublishedofficialbid
andaskpriceseveryFriday.Wesampledthemevery4weeks.
7
WeusetheCouncilofForeignBondholders,Winkler(1933),Suter(1990),anddefaultdataprovidedbyObstfeld
andTaylor(2003)todateperiodsofdefault.

11
previoustestsofthegoodͲhousekeepinghypothesisisthateachstudyusesadifferentsample.
Sinceoursampleofcountriesspansthoseconsideredinpreviousstudies,wecanexaminethe
effectofvaryingsamplecountries.Weconductourtestsonourfullsampleofcountriesaswell
asonsubsamplescorrespondingtothoseusedinBordoandRockoff(1996),Bordoand
Schwartz(1999),ObstfeldandTaylor(2003),andFlandreauandZumer(2004).Thecountriesin
thesesubsamplesarelistedinAppendix2.

4.5.CountryWeights
Itisalsoimportanttoguardagainstthepossibilitythatourconclusionsaredrivenbyoutliers.
Somecountrieshavemuchlargerbondissuesthanothersandanyconclusionsshouldberobust
toourweightingscheme.Toaddressthisproblem,weformbothvalueͲweightedandequally
weightedportfolios.ThevalueͲweightedportfolioweightseachbondbyitsmarketvalue.For
example,ifthemarketvalueofallArgentinebondsistentimesthatofDanishbonds,the
returnsofArgentinebondsreceivetentimestheweightofreturnsofDanishbondsinthe
valueͲweightedportfolio.Thus,weightingreturnsbythemarketvalueofthedebtoutstanding
weightslargebondsissuesmoreheavily.Theequallyweightedportfolioexaminesiflarge
borrowersdriveourconclusions;itconsistsofindividualcountryportfolios.8Ifthereare
ܰcountriesinthesample,thereturnofeachcountryportfolioreceivesaweightofͳΤܰ.This
weightingschememinimizestheeffectofthereturnsofbondsissuedbylargeborrowers.

5.EmpiricalResults
Table2reportstheindividualregressionresultsfortheoffͲandonͲgoldvalueͲandequally
weightedportfolios.Italsoreportstheregressionresultsfortheleveragedportfolioinequation
(3)thatislongtheoffͲgoldportfolioandshorttheonͲgoldportfolio.Thetableshowsthatthe
BritishfactormodeldoeswellinaccountingforthevariationinoffͲandonͲgoldportfolio
returns.TheadjustedRͲsquaredstatisticsarerespectableformonthlydata––between10Ͳ20%.
WhenoneformstheleveragedportfoliobytakingthedifferencebetweentheoffͲandonͲgold
portfolios,theRͲsquaredstatisticsarelow,whichsuggeststhatthereturnsfromtheleveraged

8
EachcountryportfolioisitselfvalueͲweighted.

12
portfolioareapproximatelywhitenoise.Thisfindingiswhatoneexpectsunderthenull
hypothesisthatthegoldstandardwasnotadeterminantofsovereignborrowingcosts.Sorting
bondsintooffͲandonͲgoldportfoliosshouldnotgeneratesystematicallyhigherreturns,after
controllingfortheUKmarketfactors.
 Unconditionally,thedifferencebetweenthemeanreturnofoffͲgoldandonͲgoldbonds
was1.4Ͳ1.6%peryear,dependingontheweightingscheme.Thisevidenceseemstosuggestthe
presenceofagoldpremium:OffͲgoldbondspaidhigherreturnstoinduceinvestorstohold
thembecausetheywereperceivedtoberiskier.Butprojectingthereturnsonthemarket
factorsshowsthatthedifferenceinriskͲadjustedreturns,measuredbythealphas,are
economicallysmall,statisticallyinsignificant,andhasthesignoppositetothatpredictedbythe
goodͲhousekeepinghypothesis.
 ThebetasobtainedfromtheleveragedportfolioindicatethattheoffͲgoldbond
portfolioismoresensitivetofluctuationsintheUKgovernmentconsolindexandtheBritish
corporatebondindex.Thisevidenceindicatesthatthehigherunconditionalmeanreturnofthe
offͲgoldportfoliocomparedtotheonͲgoldportfolioisattributabletotheportfolio’’sgreater
exposuretotheriskassociatedwithfluctuationsintheUKriskfactors.Thus,goinglongon
bondsissuedbycountriesoffgoldandshortingbondsissuedbycountriesongoldwouldhave
generatedpositivereturns,buttheexcessreturnsrepresentedcompensationforbearingmore
riskassociatedwithfluctuationsintheUKmarketfactorsratherfailingtoadheretothegold
standard.
Toexaminethesensitivityofthisconclusiontochangingthesample,Table3reportsthe
regressionresultsforleveragedoffͲgoldminusonͲgoldportfoliosusingdifferentsubsamplesof
countries.Dependingonthesample,sovereignoffͲgoldbondsgeneratedanaveragereturn
between1.6Ͳ2.5%higherperyearthanthereturngeneratedbybondsongold.Again,the
excessreturnisprimarilyattributabletodifferencesinexposuretobusinessͲcycleriskrather
thanmarketpunishmentfornotadheringtogold.Oncewecontrolformarketriskby
comparingtheleveragedportfoliostosimilarlyriskyBritishsecurities,theexcessreturns
vanish.Thealphasoftheleveragedportfoliosdecreaseinsizeand,inallcases,arenot
statisticallydifferentfromzero.Intwooutofthefivecountrysamples,thesignofthealphas

13
contradicttheempiricalimplicationofthegoodͲhousekeepinghypothesisinthatthealphasare
negative.InboththefullsampleandtheObstfeldͲTaylorsample,offͲgoldbondsearnedsmaller
riskͲadjustedreturnsthanonͲgoldbonds.
ThebetasinPanelAarepositive,withonlyoneexception.Ingeneral,theoffͲgold
portfolioismoresensitivetomovementsinthereturnsofUKgovernmentconsol,stock,and
corporatebondindicesthantheonͲgoldportfolios,suggestingthatthehigherunconditional
returnsassociatedwithholdingtheoffͲgoldbondswerecompensationforbearingrisk.UK
investorsdemandedapremiumtobearthisadditionalrisk,butitdidnotreflectpunishmentfor
abandoninggold.ThatthealphasareclosetozeroimpliesthataportfolioofBritishsharesand
bondswiththesameexposuretotheUKindiceswouldgeneratestatisticallyidenticalreturns.
BecausetheUKsecuritieswerenotbeingpunishedforviolatingtherulesofthegoldstandard,
theaverageexcessreturniscompensationforbearingbusinessͲcyclerisk.
 ThealphasreportedinTable3indicatethatportfoliosselectedbasedongoldͲstandard
adherencedonotoutperformportfoliosofUKsecuritieswiththesameexposuretobusinessͲ
cyclerisk.However,atestthatalphaequalszeroisajointtestofthegoodͲhousekeeping
hypothesisandtheriskandreturnmodelimpliedbytheexcessreturnregression.Tobecertain
thatthesmallalphasarenotduetomodelmisspecification,wecomparethealphasofthe
leveragedportfoliostothealphabasedonselectingbondsrandomly.
ExpectedalphawillequalzeroiftheBritishportfoliosdoagoodjobofcapturing
consumptionrisk.Butifthemodelismisspecified,theexpectedalphaofarandomportfoliowill
bedifferentfromzero.Ourconcernisamisspecifiedmodelinwhicharandomportfoliowould
havenegativealpha.Inthatcase,theportfolioselectedusinggoldͲstandardadherencecould
haveanalphastatisticallyindistinguishablefromzeroandyetstillsignificantlyoutperform
randomlyselectedportfolios.ThisfindingwouldcastdoubtonthenullhypothesisthatgoldͲ
standardadherencedoesnotmatterforsovereignborrowingcosts.
Toaddressthispossibility,wecomparethereturnsgeneratedbytheleveragedgold
portfoliotoportfoliosselectedatrandom.ForeachsubsampleinTable3,wecomputeexcess
returnportfoliosbyrandomlyassigningthesamesampleofsecuritiestooneoftwoportfolios.
BondsareassignedinthesameproportionastheproportionofgoldͲstandardadherence.We

14
compute1000randomportfoliosandreporttheproportionoftimestheportfolioselected
usingthegoldstandardcriterionearnsahigherexcessreturnthanaportfolioselectedat
random.
Forexample,inthevalueͲweightedBordoͲRockoffsampleofsovereignbonds,56%of
theobservedreturnswerereturnsofbondsonthegoldͲstandard.Wecomputeanexcess
returnportfoliofromthesamesampleofcountriesbyrandomlybuying44%ofthebondseach
periodandshortingtheother56%.Wethencalculatetherandomportfolio’’salphaand
compareittothealphaofthegoldͲsortedportfolio.Werepeattherandomselection1000
times.Theresultis1000samplealphascorrespondingtotheriskͲadjustedreturnof1000
randomlyselectedportfolios.Bycomparingthenumberoftimesthattheleveragedportfolio
generatedpositiveexcessreturnswiththenumberoftimesthatarandomlyselectedportfolio
generatedpositiveexcessreturn,weareabletoseewhethersortingbondsbygoldͲstandard
adherenceresultsinhigherreturnsthanonewouldexpectfromsortingbondsintoportfolios
randomly.
Table3reportstheproportionoftimestheleveragedgoldͲsortedportfoliosbeat
portfoliosformedatrandom,orwhatwecallthe““successrate””.Theresultsareconsistentwith
theconclusionthatgoldͲstandardadherencedidnotmatterfortheexcessreturnsofsovereign
bonds.Inthefullsample,sortingsovereignbondsintovalueͲweightedportfoliosbasedongold
wouldhaveearnedgreaterexcessreturnsthansortingbondsrandomlyonly24.1%ofthetime.
Althoughthesuccessrateexceeds50%fortheBordoͲRockoffandFlandreauͲZumersamples,it
islessthan50%fortheObtsfeldͲTaylorsample.TheObstfeldͲTaylorsamplecontainsmore
countriesthantheBordoͲRockoffandFlandreauͲZumersamplesbutfewerthanarecontained
inthefullsample,indicatingthatsomeofthedisagreementabouttheeffectofgoldon
borrowingcostsmaybeattributabletothesetofcountriesbeingstudied.Overall,portfolios
selectedbygoldͲstandardadherencedonobetterthanportfoliosselectedatrandom.
Takentogether,thesepiecesofevidenceallpointinthesamedirection.Differencesin
bondreturnsrepresentedcompensationforexposuretoBritishriskfactorsanddidnotreflecta
goldpremium.


15
5.1.RobustnessCheck:GoldͲStandardAdherenceandBetas
Differencesbetweenthereturnsofbondsissuedbycountriesongoldandthoseissuedby
countriesoffgoldappeartobeexplainedbydifferencesintheirbetas.Thefindingthatthe
betasdifferwithgoldͲstandardadherenceisnotnew.Forexample,BordoandRockoff(1996)
andObstfeldandTaylor(2003)bothobservethatthecountries’’marketbetasappeartovary
withgoldͲstandardadherence.Neithersetofauthorsformallytestsfordifferencesinthebetas
byallowingthemtovarywithgoldͲstandardadherence,butbothpointoutthatcountrieson
goldtendtohavesmallerbetasthanthoseoffgoldovertheirrespectivesamples.9Thus,itis
possiblethatgoldͲstandardadherenceandthebetasarecorrelatedwithoneanother.Inthat
case,adheringtogoldcouldreducethecostofcapitalbyreducingthebetaofacountry’’s
bonds.Theinternationalcapitalmarketmayhaveviewedbondsissuedbycountriesongoldas
lesssensitivetobusinessͲcycleriskthanthoseissuedbycountriesoffgold,sothatacountry
couldloweritscostofcapitalbyadheringtogold.
 Toexaminethispossibility,weestimatetheequationforthesubsetofourindividual
bondsthatchangetheirgoldstatus:

(4)
ܴ௜௧ െ ܴ௙௧ ൌ ߙ௜ ൅ ߚଵ ൫ܴ௖௢௡ǡ௧ െ ܴ௙௧ ൯ ൅ ߚଶ ൫ܴௌெǡ௧ െ ܴ௙௧ ൯ ൅ ߚଷ ൫ܴ஻ெǡ௧ െ ܴ௙௧ ൯ ൅ ߜଵ ൫ܴ௖௢௡ǡ௧ െ ܴ௙௧ ൯
ൈ ‫ܵܩ‬௜௧ ൅ ߜଶ ൫ܴௌெǡ௧ െ ܴ௙௧ ൯ ൈ ‫ܵܩ‬௜௧ ൅ ߜଷ ൫ܴ஻ெǡ௧ െ ܴ௙௧ ൯ ൈ ‫ܵܩ‬௜௧ ൅ ߝ௜௧ 

whereallofthevariablesaredefinedasbefore;and‫ܵܩ‬௜௧ isaninteractiondummyvariable
equalto1iftheissuingcountryisongoldattimet.Theregressionproducesthreeinteraction
coefficientsequaltothedifferencebetweenthebetaongoldandthebetaoffgold.
 Toensurethatdifferencesinthethreebetasareidentified,weneedasetofcountries
whosebondstradewhiletheissuingcountryisbothonandoffgold.Ourdatasetcontains86
suchbonds.Weestimate86separatetimeseriesregressionswhichresultin258(ൌ ͵ ൈ ͺ͸)
interactioncoefficients.Figure2showsthehistogramofthetͲstatisticsfromtheinteraction

9
Inaddition,FergusonandSchularick(2006)findthatdifferencesinmeancouponyieldsbetweenEmpireandnonͲ
EmpirebondsdisappearwhentheycontrolformarketriskandthatthebetasofEmpirebondsaresmallerthanthe
betasofnonͲEmpirebonds.

16
coefficients.Thedistributionofinteractioncoefficientsissymmetricandcenteredonzero.15
ofthe258(5.8%)arestatisticallydifferentfromzeroatthe5%significanceleveland22(8.5%)
atthe10%significancelevel.UsingtheSimes(1986)modifiedBonferronitest,wecannotreject
thejointnullhypothesisthatallinteractioncoefficientarejointlyequaltozero.Whilethe
differenceinreturnsbetweentheoffͲandonͲgoldportfolioscanbeexplainedbydifferencesin
thebetas,thedifferencesinbetasdonotappeartobeattributabletogoldͲstandard
adherence.TheresultiswhatonewouldexpectifgoldͲstandardadherencehadnoeffecton
thecostofcapital.

5.2.SensitivityAnalysis
5.2.1.Fiscal,Monetary,andTradeControls
GoldͲstandardadherencemayactasaproxyforfollowingprudentfiscalandmonetarypolicies,
asproposedbyFlandreauandZumer(2004).Itisthereforeimportanttotestifgoldreduces
sovereignborrowingcosts,conditionaloncovariatesthatcapturetherisksassociatedwith
weakfiscalandmonetarypolicies.Inaddition,otherstudiesofthegoodͲhousekeeping
hypothesishaveincludedmacroeconomiccontrolslikethelaggedinflationrateandthedeficitͲ
GDPratiotodetectdeviationsfromthecommitmenttogold(BordoandRockoff1996;and
ObstfeldandTaylor2003).Includingcovariatestocapturetheserisksinthefactormodelalso
facilitatescomparisonwiththeseotherstudies.
Wecontrolforfiscal,monetary,andtradeshocksbyformingfactorͲmimickingportfolios
usingdataonthedeficitͲGDPratio,annualinflation,andtheexportͲGDPratiothatareavailable
for22countries.10Columns1Ͳ3inTable4showthatincludingthefactorͲmimickingportfolios
hasnoeffectontheconclusions.TheoffͲgoldminusonͲgoldportfolioalpharemains
indistinguishablefromzero.

10
FamaandFrench(1995)andDanielandTitman(1997)useanidenticalproceduretoevaluatetheeffectofsize
andvaluecharacteristicsonequityreturns.WeformthefactorͲmimickingportfoliosinthefollowingway.First,at
thebeginningofeachyearwesortcountriesintothreemutuallyexclusivecategories(high,medium,andlow)
basedonthevalueofeachcharacteristic.ThehighcategorycontainsthetoponeͲthirdofcountrieswhilethelow
categorycontainsthebottomoneͲthirdofcountries.Second,weusethebondsissuedbycountriesinthehighand
lowcategoriestoformvalueͲweightedportfolios.Third,wecomputeafactorͲmimickingportfoliobyforminga
leveragedhighminuslow(HML)portfoliosforeachofthethreemacroeconomicvariables.Forexample,thedeficit
HMLportfolioistheportfolioformedbybuyingsovereignbondsinthetoponeͲthirdofthedeficitͲGDPcategory
andsellingshortthesovereignbondsinthebottomoneͲthirdofthedeficitͲGDPcategory.

17

5.2.2.ControllingfortheEmpireEffect
Accominottietal.(2010)demonstratethatdummyvariablesregressiontestsoftheeffectof
membershipintheBritishEmpireonborrowingcostsarepotentiallymisspecified.Theyshow
thatpoolingbondsissuedbyBritishcolonieswithbondsissuedbyindependentcountriescan
leadtobiasedparameterestimatesandmisleadinginferencesinyieldͲspreadregressions.To
ensurethatourconclusionsabouttheeffectofgoldstandardadherenceonsovereign
borrowingcostsarerobust,weexcludetheBritishcoloniesfromtheportfoliosortsandreͲrun
ourtestonthesubsetofbondsthatwereissuedbyindependentcountries.
 Columns4Ͳ6inTable4reportthealphasandbetasobtainedfromformingoffͲandonͲ
goldportfoliosforthesetofindependentcountriesinoursample(i.e.,bondsnotissuedby
Britishcolonies).TheunconditionaldifferencebetweenonͲgoldandoffͲgoldbondreturns
shrinkswhenweexcludecolonialbondsandtheriskͲadjustedreturnsoftheoffͲgoldminusonͲ
goldportfoliodecreases.Importantly,themainresultthatgoldͲstandardadherenceis
uncorrelatedwithriskͲadjustedreturnisunaffectedwhenthecolonialbondsareomitted.

6.Conclusion
Usingacomprehensivenewdataset,wefindnoevidenceinfavorofthegoodͲhousekeeping
hypothesis.Althoughthebondsissuedbycountriesoffofgolddidearnhigherunconditional
returnsthanthebondsofcountriesongold,thisdifferencevanishesoncewecontrolfor
exposuretocommonriskfactors.Thisevidencerejectsthegoodhousekeepinghypothesisand
isconsistentwithFlandreauandZumer’’s(2004)findingthattheeffectofgoldstandard
adherenceonborrowingcostsvanisheswiththeinclusionofotherexplanatoryvariablesthat
capturedefaultrisk.
Thisconclusionisrobust.WefindnoevidenceofagoldͲstandardeffectinanyofthesub
samplesofcountriesincludedinpreviousstudies.Theresultsarenotsensitivetoaddingfiscal,
monetary,andtradecontrolstoaccountformacroeconomicshocksthatcanaffectthe
commitmenttogold.Finally,omittingtheBritishcoloniesfromthebenchmarkspecification
doesalterourconclusions.

18
 Theseresultsshedlightontheperceivedbenefitsoftheclassicalgoldstandardin
particularandfixedexchangeͲrateregimesmoregenerally.Awidelycitedbenefitofthegold
standard––arguablythemostcrediblefixedexchangeͲrateregimeinmodernhistory––isthatit
reducedborrowingcosts.WhateverotherbenefitsacrediblyfixedexchangeͲrateregime
confersonitsadherents,theinternationalcapitalmarketdidnotrewardgoldͲstandard
adherencewithalowercostofcapital.

19
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Fama,EugeneF.,andKennethR.French.““SizeandBookͲtoͲMarketFactorsinEarningsand
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MartinͲAcena,Pablo.““SpainDuringtheClassicalGoldStandardYears,1880Ͳ1914.””InMonetary
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21
22
 Figure2.InteractionCoefficienttͲstatistics
70

60

50

40

30

20

10

0
<Ͳ2 Ͳ2 Ͳ1.5 Ͳ1 Ͳ0.5 0 0.5 1 1.5 2 >2

Notes:ThehistogramreportstherobusttͲstatisticsassociatedwiththe258interactiontermsthatresultfrom
estimatingequation(4)inthetextforeachofthe86bondsthatweretradedwhentheissuingcountrywasboth
onandoffthegoldstandard.


23
 Table1.SelectedTestsoftheGoodͲHousekeepingHypothesis

  
Authors BaselineRegressionSpecification Controlsin ܺ௜௧ᇱ 
  
ܴܵܲ‫ܦܣܧ‬௜௧ =ߙ௜ ൅ ߚ௜ ܴܵܲ‫ܦܣܧ‬ௐ௧ ൅ ߜ‫ܵܩ‬௜௧ ൅ ܺ௜௧ᇱ ߛ ൅ ߝ௜௧  Laggedmoneygrowth
BordoͲRockoff
ߝ௜௧ ൌ ߩ௜ ߝ௜௧ିଵ ൅ ‫ݑ‬௜௧ LaggeddeficitͲGNPratio
  
Laggedinflation
LaggeddebtͲoutputlevel
ExportͲGDPratio
ܴܵܲ‫ܦܣܧ‬௜௧ =ߙ௜ ൅ ߚ௜ ܴܵܲ‫ܦܣܧ‬ௐ௧ ൅ߜଵ ‫ ܨܧܦ‬ൈ ‫ܵܩ‬௜௧ ൅ ߜଶ ܱܰ‫ ܨܧܦ‬ൈ ‫ܵܩ‬௜௧ ൅ܺ௜௧ᇱ ߛ ൅ ߝ௜௧
ObstfeldͲTaylor Realincomepercapita
ߝ௜௧ ൌ ߩ௜ ߝ௜௧ିଵ ൅ ‫ݑ‬௜௧ 
Termsoftrade
BritishEmpiredummy
Wardummies
  
InterestserviceͲrevenueratio
ReservesͲbanknotesratio
Exportspercapita
DeficitͲrevenueratio
ܴܵܲ‫ܦܣܧ‬௜௧ =ߙ௜ +ߜ‫ܵܩ‬௜௧ ൅ ܺ௜௧ᇱ ߛ ൅ ߝ௜௧ 
FlandreauͲZumer ExchangeͲratevolatility
ߝ௜௧ ൌ ߩ௜ ߝ௜௧ିଵ ൅ ‫ݑ‬௜௧ 
Default
Memoryofdefault
Enfranchisedpopulation
Politicalcrisisdummies
Notes:ܴܵܲ‫ܦܣܧ‬௜௧ ൌ ܻ݈݅݁݀௜௧ െ ܻ݈݅݁݀௎௄ǡ௧ .InBordoandRockoff,ܴܵܲ‫ܦܣܧ‬ௐǡ௧ ൌ ܻ݈݅݁݀஺௏ீǡ௧ െ ܻ݈݅݁݀௎௄ǡ௧ ,whereܻ݈݅݁݀஺௏ீǡ௧ istheaverageofallcoupon
yieldsintheirsample.InObstfeldandTaylor,ܴܵܲ‫ܦܣܧ‬ௐǡ௧ ൌ ܻ݈݅݁݀ௐǡ௧ െ ܻ݈݅݁݀௎௄ǡ௧ ,whereܻ݈݅݁݀ௐǡ௧ istheGDPͲweightedaverageofallcouponyields
intheirsample.


 

24
 Table2.ExcessReturnRegressions:OffandOnͲGoldPortfolios
 
 

  ValueͲWeighted    EquallyWeighted 
 OffGold OnGold OffെOn  OffGold OnGold OffെOn

MeanExcessReturn 4.24 2.71 1.53  4.33 2.90 1.43

ߙ Ͳ0.11 0.49 Ͳ0.59  Ͳ0.90 0.91* Ͳ1.80
(Ͳ0.08) (0.72) (Ͳ0.44) (Ͳ0.51) (1.92) (Ͳ1.09)
       
ߚ஼ைே  0.359*** 0.132*** 0.227**  0.321*** 0.153*** 0.168
(3.97) (2.78) (2.40) (2.60) (4.63) (1.45)
       
ߚெ௄்  0.407*** 0.305*** 0.101  0.730*** 0.245*** 0.485***
(5.00) (7.18) (1.19) (6.57) (8.26) (4.66)
       
ߚ஼ைோ௉  0.365*** 0.100* 0.265***  0.212 0.101*** 0.111
(3.73) (1.96) (2.58) (1.58) (2.83) (0.88)
       
ܴതଶ  0.208 0.126 0.062  0.179 0.180 0.087
 

Notes:Theregressionsareequations(2)and(3).Themeanexcessreturnandestimatedalphaareexpressedinannualized
percentagepoints.RobusttͲstatisticsareinparentheses.***(**)(*)indicatessignificanceatthe1%(5%)(10%)level.

25
 Table3.Excess28ͲdayReturnRegressions:OffͲGoldPortfolio––OnGoldPortfolio

PanelA:ValueͲWeighted
 Full BordoͲRockoff BordoͲSchwartz ObstfeldͲTaylor FlandreauͲZumer

MeanExcessReturn 1.53 2.33 1.58 2.26 2.52

ߙ  Ͳ0.59 0.48 0.08 Ͳ0.37 0.70
(Ͳ0.44) (0.34) (0.07) (Ͳ0.23) (0.49)
 

ߚ஼ைே  0.227** 0.141 0.052 0.217** 0.314***

(2.40) (1.45) (0.60) (1.99) (3.18)
 

ߚெ௄்  0.101 Ͳ0.000 0.167** 0.134 Ͳ0.013

(1.19) (Ͳ0.01) (2.17) (1.37) (0.15)
 

ߚ஼ைோ௉  0.265*** 0.387*** 0.145 0.365*** 0.272**

(2.58) (3.69) (1.56) (3.09) (2.54)
 

ܴതଶ  0.062 0.045 0.027 0.069 0.047

SuccessRate 24.1% 68.9% 48.4% 39.1% 78.7%
 
 

PanelB:EquallyWeighted
 Full BordoͲRockoff BordoͲSchwartz ObstfeldͲTaylor FlandreauͲZumer
MeanExcessReturn 1.43 2.39 2.29 2.22 2.36
ߙ  Ͳ1.80 0.91 0.95 Ͳ0.39 0.39
(Ͳ1.09) (0.75) (0.82) (Ͳ0.28) (0.32)
 

ߚ஼ைே  0.168 0.082 0.011 0.094 0.187**

(1.45) (0.97) (0.14) (0.97) (2.19)
 

ߚெ௄்  0.485*** 0.076 0.167** 0.304*** 0.154**

(4.66) (1.01) (2.29) (3.50) (2.01)
 

ߚ஼ைோ௉  0.111 0.232** 0.130 0.231** 0.188**

(0.88) (2.54) (1.48) (2.21) (2.04)
 

ܴതଶ  0.087 0.030 0.028 0.078 0.053

SuccessRate 8.0% 78.1% 84.2% 36.2% 64.3%
 

Notes:Theregressionsareequations(2)and(3).Themeanexcessreturnandestimatedalphaareexpressedin
annualizedpercentagepoints.RobusttͲstatisticsareinparentheses.***(**)(*)indicatessignificanceatthe1%
(5%)(10%)level.

26
 Table4.ExcessReturnRegressions:MacroeconomicRiskFactorsandIndependentCountries

       
 FullSample  Ind.Countries

 OffGold OnGold OffെOn  OffGold OnGold OffെOn

MeanExcessReturn 4.27 2.59 1.68  4.24 3.21 1.02

ߙ  0.03 0.24 Ͳ0.21  Ͳ0.11 0.81 Ͳ0.92

(0.02) (0.36) (Ͳ0.16) (Ͳ0.08) (1.01) (Ͳ0.65)
       
ߚ஼ைே  0.345*** 0.157*** 0.188**  0.359*** 0.117** 0.242**
(3.86) (3.40) (2.00) (3.97) (2.07) (2.46)
       
ߚெ௄்  0.366*** 0.185*** 0.181**  0.407*** 0.353*** 0.054
(4.48) (4.39) (2.10) (5.01) (6.98) (0.611)
       
ߚ஼ைோ௉  0.381*** 0.143*** 0.238**  0.365*** 0.097 0.268**
(3.97) (2.89) (Ͳ2.35) (3.73) (1.59) (2.52)
       
ߚ஽ாிିீ஽௉  Ͳ0.061 0.089*** Ͳ0.150**   

(Ͳ1.03) (2.94) (Ͳ2.41)
       
ߚூேி  Ͳ0.124*** Ͳ0.053** Ͳ0.071   

(Ͳ2.88) (Ͳ2.38) (Ͳ1.57)
       
ߚா௑௉ିீ஽௉  Ͳ0.172*** Ͳ0.189*** 0.017   

(Ͳ3.75) (Ͳ8.01) (0.36)
       
ܴത ଶ  0.237 0.252 0.091  0.208 0.112 0.052
Notes:Theregressionsareequations(2)and(3).TheportfoliosarevalueͲweighted.Themeanexcessreturnand
estimatedalphaareexpressedinannualizedpercentagepoints.The““Ind.Countries””sampleincludesall
independentcountriesinoursampleandexcludestheBritishcolonies.““DefͲGDP””,““Inf””,and““ExpͲGDP””referto
thecoefficientsassociatedwiththefactorͲmimickingportfoliosdescribedinthetext.RobusttͲstatisticsarein
parentheses.***(**)(*)indicatessignificanceatthe1%(5%)(10%)level.

27
 Appendix1:SampleofCountries
Thedatasetincludes213sovereignbondsissuedby37nonͲcolonialcountriesand110colonial
bondsissuedby12Britishcoloniesandpossessions.Thepricesaresampledevery28daysfrom
theofficialquotationlistpublishedintheMoneyMarketReviewandtheEconomistfrom1866
until1907,whenthepublisherceasedprovidingsuchdetailedpricequotations.Weusethe
price,dividend,andcoupondatatocomputeatimeseriesofrealizedholdingͲperiodreturns
correctedfordividends,stocksplits,andsovereigndefaults.Todatesovereigndefaults,werely
ontheannualreportsissuedbytheCouncilofForeignBondholders,Winkler(1933),andSuter
(1990).Intheregressions,thetimeseriesspantheperiodfromJanuary1870untilDecember
1907duetodataconstraints.

SovereignBondData
Thecountriesincludedinourdatasetare:Argentina;Australia;AustriaͲHungary;Belgium;
Brazil;BritishGuiana;Bulgaria;Canada;Ceylon;Chile;China;Colombia;CostaRica;Denmark;
Ecuador;Egypt;France;Germany;Greece;Guatemala;Hawaii;Honduras;HongKong;Italy;
Jamaica;Japan;Liberia;Mauritius;Mexico;Netherlands;NewZealand;Nicaragua;Norway;
OrangeFreeState;Paraguay;Peru;Portugal;Russia;SaintLucia;SantoDomingo;SouthAfrica;
Spain;StraitsSettlements;Sweden;Trinidad;Turkey;UnitedStates;Uruguay;andVenezuela.

TheBritishcoloniesandpossessionsareasubsetofthecountriesinthefullsample.Theyare:
Australia;BritishGuiana;Canada;Ceylon;HongKong;Jamaica;Mauritius;NewZealand;Saint
Lucia;SouthAfrica;StraitsSettlements;andTrinidad.

Subsamples
Weformedsubsamplesofcountriesbaseduponpreviousworkonthegoldstandard.Weare
abletomimiccloselyeachofthesamplesofcountrieslistedbelow.

BordoandRockoff(1996):Argentina;Australia;Brazil;Canada;Chile;Italy;Portugal;Spain;and
UnitedStates.

28

BordoandSchwartz(1999):Argentina;Australia;Belgium;Brazil;Canada;Chile;Denmark;
Finland;Greece;Italy;Japan;Netherlands;Norway;Portugal;Sweden;andSwitzerland.The
fourcorecountriesareFrance,Germany,theUK,andtheUnitedStates.WeexcludeFinland
andSwitzerlandduetolackofdata.

ObstfeldandTaylor(2003):Argentina;Australia;AustriaͲHungary;Brazil;Canada;Chile;Egypt;
Greece;India;Italy;Japan;Mexico;NewZealand;Norway;Portugal;SouthAfrica;Spain;
Sweden;Turkey;theUnitedStates;andUruguay.

FlandreauandZumer(2004):Argentina;AustriaͲHungary;Belgium;Brazil;Denmark;France;
Germany;Greece;Italy;Netherlands;Norway;Portugal;Spain;Sweden;Switzerland;and
Russia.WeexcludeSwitzerlandduetolackofdata.

WeadoptthedefinitionofcheaterfromBordoandSchwartz’’sTable1(BordoandSchwartz
1999).Wecodeacountryasacheaterifitsuspendedgoldconvertibilitybecauseofwar,lax
fiscalpolicy,afinancialcrisis,failedconvertibility,orsomecombinationofthefour.The
countriesthatfallintothiscategoryareArgentina,Brazil,Chile,Greece,Italy,andPortugal.
 

29
 Appendix2:GoldͲstandardadherence
Argentina:January3,1867ͲMay1876:LeavinggoldinMay1876didnotresultinachangein
parity.July1883ͲDecember1884:LeavinggoldinDecember1884didnotresultinachangeof
parity.October31,1899:Lawestablishingexternalconvertibility.Source:dellaPaoleraand
Taylor(2001),pp.25,41,47.

Australia:Adoptedthefreeconvertibilityofcurrencyintogoldbefore1870.Source:Meissner
(2005).

AustriaͲHungary:August2,1892.Source:Helfferich(1927),pp.200.

Belgium:November5,1878.Source:Helfferich(1927),pp.180.

Brazil:October1888ͲOctober1890.LeavinggoldinOctober1890didnotresultinachangeof
parity.December31,1906:ConversionOfficeopened.Sources:MartinͲAcena(2000),pp155;
andSubercaseaux(1931).

BritishGuiana:Adoptedthefreeconvertibilityofcurrencyintogoldbefore1870.Source:
Officer(2001).

Bulgaria:Didnotadoptthefreeconvertibilityofcurrencyintogoldbefore1914.Source:
Meissner(2005).

Canada:Adoptedthefreeconvertibilityofcurrencyintogoldbefore1870.Newfoundlanddid
notadoptthefreeconvertibilityofcurrencyintogolduntil1895,accordingtoOfficer(2001).
WedatethebondsfromNewfoundlandfromJanuary1,1895.Sources:Meissner(2005).

Ceylon:1898.WedateCeylonasadheringtothegoldstandardfromJanuary1,1898.Source:
Officer(2001).

Chile:LawpassedFebruary11,1895providingforconversionfromJune1,1895.Suspended
convertibilityJuly31,1898.Thiseventresultedinachangeofparity.Source:Kemmerer(1926).

China:Didnotadoptthefreeconvertibilityofcurrencyintogoldbefore1914.Source:
Bloomfield(1959).

Colombia:From1903,Colombiahasfixedgoldparities,butitdidnotadoptacompletegold
standarduntil1923,whenthefirstKemmererMissionintervened.WecodeColombiaasnot

30
adoptingthefreeconvertibilityofcurrencyintogoldbefore1914.Source:MartinͲAcena(2000),
pp.237.

CostaRica:LawpassedinOctober1896,butcurrencywasnotconvertibleintogolduntilJuly
15,1900.WedateitfromNovember1896.Source:Young(1925),pp.193Ͳ96.

Denmark:AgreementreachedDecember18,1872.FormedmonetaryunionwithSwedenin
May1873.WedateitfromJune1873.Sources:Helfferich(1927),pp.175;andJonung(1984),
pp.367.

Ecuador:1900.WedateEcuadorasadheringtothegoldstandardfromJanuary1,1900.
Source:Meissner(2005).

Egypt:1885.WedateEgyptasadheringtothegoldstandardfromJanuary1,1885.Source:
Officer(2001).

France:November5,1878.Source:Helfferich(1927),pp.180.

Germany:December4,1871.Source:Helfferich(1927),pp.156Ͳ7.

Greece:January1885ͲSeptember1885.Thiseventdidnotresultinachangeofparity.Greece
didnotjointhegoldstandardagainuntilMarch1910.Sources:BordoandSchwartz(1999),pp.
251;andLazaretou(2005).

Guatemala:Didnotadoptthefreeconvertibilityofcurrencyintogoldbefore1914.Source:
BulmerͲThomas(2003),pp112.

Hawaii:AdoptedtheGoldLawof1884,whichmadethegoldcoinsoftheUnitedStateslegal
tender.WedateHawaiiasadheringtothegoldstandardfromJanuary1,1884.Source:Tate
(1965),pp.69.

Honduras:Didnotadoptthefreeconvertibilityofcurrencyintogoldbefore1914.Source:
BulmerͲThomas(2003),pp112.

HongKong:Didnotadoptthefreeconvertibilityofcurrencyintogoldbefore1914.Source:Tom
(1989).


31
Italy:LawestablishingconvertibilityApril12,1884passedMarch1,1883.Affidavitintroduced
onsecondsemestercouponpaymentsinJuly1893.RequiredItalianstoswearrenditacoupon
paymentsreceivedabroaddidnotbelongtoItaliancitizens.Introducedincentivesforlenders
toredeeminMilan.Thiseventresultedinachangeinparity.Sources:Helfferich(1927),pp.
175;andFratianniandSpinelli(1984),pp.415.

Jamaica:Adoptedthefreeconvertibilityofcurrencyintogoldbefore1870.Source:Officer
(2001).

Japan:LawpassedMarch29,1897providingforconversionbetweenOctober1,1897ͲJuly31,
1898.Sources:Helfferich(1927),pp.201;andLaughlin(1900).

Liberia:PeggedtoUSdollarattheexchangerateL$1=US$1.WecodeitthesameastheUS.
Source:http://users.erols.com/kurrency/africa.htm

Mauritius:1898.WedateMauritiusasadheringtothegoldstandardfromJanuary1,1898.
Source:Officer(2001).

Mexico:LawpassedDecember9,1904.DecreeenforcedMarch25,1905.Source:Helfferich
(1927),pp.204.

Netherlands:June6,1875.Source:Helfferich(1927),pp.176.

NewZealand:Adoptedthefreeconvertibilityofcurrencyintogoldbefore1870.Source:Officer
(2001).

Nicaragua:Didnotadoptthefreeconvertibilityofcurrencyintogoldbefore1914.Sources:
BulmerͲThomas(2003),pp115;andYoung(1925),pp.119Ͳ30;AppendixE.

Norway:AgreementreachedDecember18,1872.Norwayformedamonetaryunionwith
DenmarkandSwedeninOctober1875.Sources:Helfferich(1927),pp.175;andJonung(1984),
pp.367.

OrangeFreeState:1870ͲDecember14,1899.December15,1899ͲMarch14,1900:Gold
standardsuspended.March15,1900Ͳ1910:GoldstandardreͲestablished.Source:
http://users.erols.com/kurrency/africa.htm


32
Paraguay:Didnotadoptthefreeconvertibilityofcurrencyintogoldbefore1914.Source:
BulmerͲThomas(2003),pp114.

Peru:Didnotadoptthefreeconvertibilityofcurrencyintogoldbefore1914.Source:Meissner
(2005).

Portugal:1854ͲMay1891.Thiseventresultedinachangeinparity.Source:Reis(2000),pp94.

Russia:February1897.Source:Anonymous(1897).

St.Lucia:Adoptedthefreeconvertibilityofcurrencyintogoldbefore1870.Source:Officer
(2001).

SantoDomingo:Didnotadoptthefreeconvertibilityofcurrencyintogoldbefore1914.
Sources:Laughlin(1894);andMeissner(2005).

SouthAfrica:Adoptedthefreeconvertibilityofcurrencyintogoldbefore1870.Source:Officer
(2001).

Spain:Suspendedsummer1883becauseofdeclineinforeigninvestmentafterJanuary1882
stockmarketcrash.Theprecisedateisvague,andwedateitfromtheendofJune1883.
Source:MartinͲAcena(2000),pp128.

StraitsSettlements:1903.WedatetheStraitsSettlementsasadheringtothegoldstandard
fromJanuary1,1903.Source:Meissner(2005).

Sweden:AgreementreachedDecember18,1872.FormedmonetaryunionwithDenmarkin
May1873.Sources:Helfferich(1927),pp.175;andJonung(1984),pp.367.

Trinidad:Adoptedthefreeconvertibilityofcurrencyintogoldbefore1870.Source:Officer
(2001).

Turkey:1881.WedateTurkeyasadheringtothegoldstandardfromJanuary1,1881Sources:
Pamuk(2000),pp.218.

UnitedStates:January1,1879.Source:Officer(2001).


33
Uruguay:1885.WedateUruguayasadheringtothegoldstandardfromJanuary1,1885.
Source:Meissner(2005).

Venezuela:Didnotadoptthefreeconvertibilityofcurrencyintogoldbefore1914.Source:
Meissner(2005).
 

34
AppendixReferences
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244.

Bloomfield,Arthur.MonetaryPolicyUndertheGoldStandard.NewYork:FederalReserveBank
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Bordo,MichaelD.,andAnnaJ.Schwartz.““TheOperationoftheSpecieStandard:Evidencefor
CoreandPeripheralCountries:1880Ͳ1990.””InTheGoldStandardandRelatedRegimes:
CollectedEssays,editedbyMichaelD.Bordo,238Ͳ317.NewYork:CambridgeUniversityPress,
1999.

BulmerͲThomas,Victor.TheEconomicHistoryofLatinAmericasinceIndependence.NewYork:
CambridgeUniversityPress,2003.

DellaPaolera,Gerardo,andAlanTaylor.StrainingattheAnchor:TheArgentineCurrencyBoard
andtheSearchforMacroeconomicStability:1880Ͳ1935.Chicago:UniversityofChicagoPress,
2001.

Fratianni,Michele,andFrancoSpinelli.““ItalyintheGoldStandardPeriod,1861Ͳ1914.””InA
RetrospectiveontheClassicalGoldStandard:1821Ͳ1931,editedbyMichaelD.BordoandAnna
J.Schwartz,405Ͳ454.Chicago:UniversityofChicagoPress,1984.

Helfferich,Karl.Money,2vols.TranslatedbyLouisInfield.NewYork:AdelphiCompany
Publishers,1927.

Jonung,Lars.““SwedishExperienceundertheClassicalGoldStandard:1873Ͳ1914.””InA
RetrospectiveontheClassicalGoldStandard:1821Ͳ1931,editedbyMichaelD.BordoandAnna
J.Schwartz,361Ͳ399.Chicago:UniversityofChicagoPress,1984.

Kemmerer,EdwinWalter.““ChileReturnstoGoldStandard.””JournalofPoliticalEconomy34,no.
3(1926):265Ͳ273.

Laughlin,J.Laurence.““GoldandSilverinSantoDomingo.””JournalofPoliticalEconomy2,no.4
(1894):536Ͳ560.

__________““ReportontheAdoptionoftheGoldStandardinJapan.””JournalofPolitical
Economy8,no.3(1900):424Ͳ427.

35

Lazaretou,Sophia.““TheDrachma,ForeignCreditors,andtheInternationalMonetarySystem:
TalesofaCurrencyduringthe19thand20thCenturies.””ExplorationsinEconomicHistory42,no.
2(2005):202Ͳ236.

MartinͲAcena,Pablo.““TheSpanishMonetaryExperience:1848Ͳ1914.””InMonetaryStandards
inthePeriphery,editedbyPabloMartinAcenaandJaimeReis,112Ͳ151.NewYork:St.Martin’’s
Press,2000.

Meissner,Chris.““ANewWorldOrder:ExplainingtheInternationalDiffusionoftheGold
Standard,1870Ͳ1913.””JournalofInternationalEconomics66,no.2(2005):385Ͳ406.

Officer,Lawrence.““GoldStandard.””EH.NetEncyclopedia,editedbyRobertWhaples.October1,
2001.URLhttp://eh.net/encyclopedia/article/officer.gold.standard

Pamuk,Sevket.AMonetaryHistoryoftheOttomanEmpire.NewYork:CambridgeUniversity
Press,2000.

Reis,Jamie.““TheGoldStandardinPortugal:1854Ͳ1891.””InMonetaryStandardsinthe
Periphery,editedbyPabloMartinͲAcenaandJaimeReis,69Ͳ111.NewYork:St.Martin’’sPress,
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Subercaseaux,Guillermo.““TheModernGoldStandardwithIllustrationsfromSouthAmerica.””
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Suter,Christian.SchuldenzykleninderdrittenWelt:Kreditaufnahme,Zahlungskrisenund
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Tate,Merze.TheUnitedStatesandtheHawaiianKingdom.NewHavenandLondon:Yale
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Winkler,Max.ForeignBonds:AnAutopsy.NewYork:RolandSwainCompany,1933.

36

Young,JohnParke.CentralAmericanCurrencyandFinance.Princeton:PrincetonUniversity
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37
Working Paper Series
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