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Financing Development: The Role of Information Costs

To address how technological progress in financial intermediation affects the economy, a costly-state verification framework is embedded into the standard growth model. The framework has two novel ingredients. First, firms differ in the risk/return combinations that they offer. Second, the efficacy of monitoring depends upon the amount of resources invested in the activity. A financial theory of firm size results. Undeserving firms are over financed, deserving ones under funded. Technological advance in intermediation leads to more capital accumulation and a redirection of funds away from unproductive firms toward productive ones. With continued progress, the economy approaches its first-best equilibrium. An extended version of the paper containing some quantitative analysis is available at: http://ssrn.com/abstract=996263

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Paper provided by Economie d'Avant Garde in its series Economie d'Avant Garde Research Reports with number 14.

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Length: 60 pages
Date of creation: Mar 2007
Date of revision:
Handle: RePEc:eag:rereps:14
Contact details of provider: Web page: http://www.jeremygreenwood.net/EAG.htm

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