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Investor Protection and Income Inequality: Risk Sharing vs Risk Taking

  • Alessandra Bonfiglioli

This paper studies the relationship between investor protection, entrepreneurial risk taking and income in equality. In the presence of market frictions, better protection makes investors more willing to take on entrepreneurial risk when lending to firms, thereby improving the degree of risk sharing between financiers and entrepreneurs. On the other hand, by increasing risk sharing, investor protection also induces more firms to undertake risky projects. By increasing entrepreneurial risk taking, it raises income dispersion. By reducing the risk faced by entrepreneurs, it reduces income volatility. As a result, investor protection raises income inequality to the extent that it fosters risk taking, while it reduces it for a given level of risk taking. Empirical evidence from a panel of forty-five countries spanning the period 1976-2000 supports the predictions of the model.

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Paper provided by Barcelona Graduate School of Economics in its series Working Papers with number 461.

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Date of creation: May 2010
Handle: RePEc:bge:wpaper:461
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