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Equities and Inequality

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  • Alessandra Bonfiglioli

Abstract

This paper studies the relationship between the development of stock markets and income inequality. It shows that introducing equity financing in an economy with safe and risky sectors, where debt is initially the only financial instrument and where market imperfections generate credit rationing in the risky sector, raises both income dispersion in general and income differentials between skill groups. While the latter increase with stock market capitalization, income dispersion rises until the equity market reaches a certain size, then it declines. Equities play the twofold role of allowing some credit rationed agents to finance risky enterprises, and providing insurance through risk sharing. The degree of investor protection ultimately determines the size of the equity market and the extent of risk-sharing. By increasing the number of risky projects, better investor protection widens income dispersion. On the other hand, by improving risk sharing, it tends to reduce inequality. This tension explains the inverted-U shaped relationship between income inequality and stock market development. Empirical evidence on a panel of fifty-two countries spanning the years 1976-2000 supports the predictions of the model

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 256.

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Date of creation: 2004
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Handle: RePEc:red:sed004:256

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Keywords: International Income Distribution; Financial Development; Dynamic Panel Data;

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Cited by:
  1. Manoel Bittencourt, 2007. "Financial Development and Inequality: Brazil 1985-1994," Ibero America Institute for Econ. Research (IAI) Discussion Papers 164, Ibero-America Institute for Economic Research.
  2. Bertola, Giuseppe, 2007. "Finance and Welfare States in Globalizing Markets," CEPR Discussion Papers 6480, C.E.P.R. Discussion Papers.
  3. Bittencourt, Manoel, 2011. "Inflation and financial development: Evidence from Brazil," Economic Modelling, Elsevier, vol. 28(1), pages 91-99.
  4. Muhammad, Shahbaz & Tiwari, Aviral & Reza, Sherafatian-Jahromi, 2012. "Financial Development and Income Inequality: Is there any Financial Kuznets curve in Iran?," MPRA Paper 40899, University Library of Munich, Germany, revised 26 Aug 2012.
  5. Alimi, R. Santos, 2014. "Inflation and Financial Sector Performance: The Case Of Nigeria," MPRA Paper 57180, University Library of Munich, Germany.
  6. Abu N. M., Wahid & Muhammad, Shahbaz & Pervez, Azeem, 2011. "Inflation and financial sector correlation: the case of Bangladesh," MPRA Paper 32935, University Library of Munich, Germany, revised 20 Aug 2011.

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