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Liquidity needs and vulnerability to financial udnerdevelopment

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Author Info
Raddatz, Claudio

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Abstract

The author provides evidence of a causal and economically important effect of financial development on volatility. In contrast to the existing literature, the identification strategy is based on the differences in sensitivities to financial conditions across industries. The results show that sectors with larger liquidity needs are more volatile and experience deeper crises in financially underdeveloped countries. At the macroeconomic level, the results suggest that changes in financial development can generate important differences in aggregate volatility. The author also finds that financially underdeveloped countries partially protect themselves from volatility by concentrating less output in sectors with large liquidity needs. Nevertheless, this insulation mechanism seems to be insufficient to reverse the effects of financial underdevelopment on within-sector volatility. Finally, the author provides new evidence that: 1) Financial development affects volatility mainly through the intensive margin (output per firm). 2) Both the quality of information generated by firms, and the development of financial intermediaries have independent effects on sectoral volatility. 3) The development of financial intermediaries is more important than the development of equity markets for the reduction of volatility.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 3161.

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Date of creation: 30 Nov 2003
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Handle: RePEc:wbk:wbrwps:3161

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Keywords: Payment Systems&Infrastructure; Economic Theory&Research; Markets and Market Access; Fiscal&Monetary Policy; Financial Crisis Management&Restructuring; Economic Theory&Research; Financial Crisis Management&Restructuring; Fiscal&Monetary Policy; Development Economics&Aid Effectiveness; Markets and Market Access;

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  6. Greenwood, Jeremy & Jovanovic, Boyan, 1990. "Financial Development, Growth, and the Distribution of Income," Journal of Political Economy, University of Chicago Press, vol. 98(5), pages 1076-1107, October. [Downloadable!] (restricted)
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  7. Gertler, Mark & Gilchrist, Simon, 1994. "Monetary Policy, Business Cycles, and the Behavior of Small Manufacturing Firms," The Quarterly Journal of Economics, MIT Press, vol. 109(2), pages 309-40, May. [Downloadable!] (restricted)
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  14. Berndt, Ernst R. & Morrison, Catherine J., 1995. "High-tech capital formation and economic performance in U.S. manufacturing industries An exploratory analysis," Journal of Econometrics, Elsevier, vol. 65(1), pages 9-43, January. [Downloadable!] (restricted)
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  19. Ramey, Valerie A, 1989. "Inventories as Factors of Production and Economic Fluctuations," American Economic Review, American Economic Association, vol. 79(3), pages 338-54, June. [Downloadable!] (restricted)
  20. Olivier Blanchard & John Simon, 2001. "The Long and Large Decline in U.S. Output Volatility," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 32(2001-1), pages 135-174. [Downloadable!]
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  22. Smith, Richard J & Blundell, Richard W, 1986. "An Exogeneity Test for a Simultaneous Equation Tobit Model with an Application to Labor Supply," Econometrica, Econometric Society, vol. 54(3), pages 679-85, May. [Downloadable!] (restricted)
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