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Financing development : the role of information costs

  • Jeremy Greenwood
  • Juan M. Sanchez
  • Cheng Wang

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 features. 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 underfunded. Technological advance in intermediation leads to more capital accumulation and a redirection of funds away from unproductive firms toward productive ones. Quantitative analysis suggests that finance is important for growth.

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Paper provided by Federal Reserve Bank of Richmond in its series Working Paper with number 08-08.

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Date of creation: 2009
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Handle: RePEc:fip:fedrwp:08-08
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