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Essays on financial structure and economic activity under asymmetric information

Leonarda Zicchino, 2002
Faculty Advisor: Paolo Siconolfi
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Abstract

This dissertation provides an analysis of the relationship between the financial and the real sector of an economy with asymmetric information. The first chapter addresses the effect of adverse selection on the growth process. It shows that an economy may have two possible competitive equilibria with distinct bank contracts, interest rates on deposits and individuals' investment portfolios. The equilibrium outcome depends on the level of aggregate wealth and on the parameter values describing the firms' heterogeneous marginal productivity of capital. Thus, as the economy grows, the financial structure may evolve. Finally, the dynamics of the economy can be described by either (a) a monotonically increasing law of motion of wealth with a unique steady state characterized by the coexistence of banks and a stock market; or (b) a monotonically increasing law of motion with a kink and either one or three steady states.

The second chapter analyzes the relationship between financial markets and capital formation in the presence of moral hazard. The economy may have two possible competitive equilibria. In one case firms adopt a safe investment technology and individuals allocate their savings both in bank deposits and firms' shares. The other possible equilibrium entails the disappearance of the stock market. Moreover, economies with different initial levels of wealth may converge to steady states characterized by either a low or a high level of capital accumulation.

Finally, the economy may experience output fluctuations with contractions involving an increase in credit rationing.

The third chapter provides an analysis of the dynamic relationship between firms' financial conditions and the investment level by using firm-level panel data from 36 countries. The coefficient estimates resulting from the Vector Autoregression and the impulse-response functions support our claim that in the presence of financing constraints, which are more stringent in countries with an undeveloped financial system, the availability of liquid assets affects firms' investment decisions.

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