Industry Diversification and Financial Development

Córdoba

Congreso; Arnoldshain Seminar XXXIX; 2016

Universidad Nacional de Córdoba

This paper studies industry or sector diversification as a determinantto financial development. The theoretical model predicts thatbanks lend more, and hold less liquid funds, in a more diversified economybecause the aggregate credit risk is lower when a more diversifiedlending portfolio is possible. Thus, the reduction in the aggregatecredit risk given by a higher degree of industrial diversification determinesfinancial development. The empirical results supports thishypothesis by finding both cross-section and panel data evidence thatthere is a robust relationship between industry (or sector) diversificationand financial development. The policy implications are that thegovernment may foster financial development by subsidizing horizontalR&D in order to create new industries or sectors.