A New Perspective on the Finance-Development Nexus

31 Pages Posted: 5 Dec 2016

See all articles by Pedro S. Amaral

Pedro S. Amaral

California State University, Fullerton - Department of Economics

Dean Corbae

University of Wisconsin - Madison

Erwan Quintin

University of Wisconsin - Madison

Date Written: December 2, 2016

Abstract

The existing literature on financial development focuses mostly on the causal impact of the quantity of financial intermediation on economic development. This paper, instead, focuses on the role of the financial sector in creating securities that cater to the needs of heterogeneous investors. To that end, we describe a dynamic extension of Allen and Gale (1989)’s optimal security design model in which producers can tranche the stochastic cash flows they generate at a cost. Lower tranching costs in that environment lead to capital deepening and raise aggregate output. The implications of lower tranching costs for TFP, on the other hand, are fundamentally ambiguous. In other words, our model predicts that increased financial sophistication/complexity — a securitization boom, e.g. — can have adverse consequences on aggregate productivity as it is conventionally measured.

Keywords: Endogenous security markets, financial development, economic development.

JEL Classification: E44; E30

Suggested Citation

Amaral, Pedro S. and Corbae, Dean and Quintin, Erwan, A New Perspective on the Finance-Development Nexus (December 2, 2016). Federal Reserve Bank of Cleveland, Working Paper no. 16-29, Available at SSRN: https://ssrn.com/abstract=2879634

Pedro S. Amaral (Contact Author)

California State University, Fullerton - Department of Economics ( email )

Fullerton, CA 92834
United States

Dean Corbae

University of Wisconsin - Madison ( email )

716 Langdon Street
Madison, WI 53706-1481
United States

Erwan Quintin

University of Wisconsin - Madison ( email )

716 Langdon Street
Madison, WI 53706-1481
United States

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