Download Financial Volatility and Growth

Financial Sector Volatility, Banking
Market Structure and Exports
Pei-Chien Lin
Department of Industrial Economics
Tamkang University
Ho-Chuan (River) Huang
Department of Banking and Finance
Tamkang University
April 21, 2014
1. Introduction : Research background

Investigation on the finance-growth nexus has been
one of the most prolific areas in the field of
development, finance, and international economics.

Recently, a ramification extended to the literature of
international trade suggests that financial development
could also be a source of a country’s comparative
advantage.
1. Introduction : Research background

Theoretical literature: Kletzer and Bardhan (1987) and
Baldwin (1989) augmented the Hecksher-Ohlin model by
incorporating a financial sector and shows that financial
development gives countries a comparative advantage in
industries relying more on external finance.

Several empirical studies, such as Beck(2002,2003),
Svaleryd and Vlachos (2005), Hur et al.(2006) and
Manova (2008) have provided evidence to support the
theoretical prediction.
1. Introduction : Research background

More recently, some studies have been extended to
consider the impact of other financial features on real
economic activities, such as considering the impact of
financial volatility on economic growth, e.g., Loayza
and Ranciere(2006) and Kim, Lin and Suen (2010), Lin
and Huang (2012) and the impact of banking market
structure on economic growth, e.g., Cetorelli and
Gambera (2001) and Claessens and Laeven (2005).

Nevertheless, the literature has not paid much attention
to examining the impacts of financial volatility and
banking market structure on trade patterns so far. And
studying this issue may shed light on the legitimacy of
financial supervision and the reform of financial sector
for those more open economies.
1. Introduction : Rationale between
financial volatility and real activity


According to Mishkin (1999), asymmetric information
between lender and borrower leads to two basic
problems in the financial system: adverse selection and
moral hazard.
Financial instability (or volatility) generally will
worsen the problems of adverse selection and moral
hazard and thus drive up the possibility of lending bad
credits. Consequently, lenders will be reluctant to make
more loans, thereby possibly leading to a steep decline
in lending and that will result in substantially lower
investment and real economic activity.
1. Introduction : Theoretical prediction between
banking market structure and real activity



On the positive side, less competitive system may lead
to easier access to external financing because banks,
with more market power, are more inclined to invest in
information acquisition and customer relationship, e.g.,
Mayer (1988,1990) and Petersen and Rajan (1995).
Oppositely, the less competitive system may make the
financial service more costly or with low quality,
thereby reducing the effective demand of external
financing and hence discouraging real activity, e.g.,
Pagano (1993).
Accordingly, linkage between banking market structure
and real activity remains as an empirical issue.
1. Introduction : Purpose of this paper

To complement the extant literature, this paper
plans to further empirically assess the impacts
of other financial features, such as financial
sector volatility and banking market structure,
on industrial export.
2. Methodology : Empirical concerns (1)


Concern 1: reverse causality
-> the performance of exports can be the source of
financial sector volatility.
Solution: Following Rajan and Zingales (thereafter RZ,
1998), we describe a channel through which the
industries might grow differentially in countries where
the channel is likely to be more operative.
2. Methodology : Empirical concerns (1)
Country 1
External financing
Industry 1 (high)
Export
External financing
Industry 2 (low)
Export
External financing
Industry 1 (high)
Export
External financing
Industry 2 (low)
Export
Banking industry with
higher volatility
Country 2
Banking industry with
lower volatility
2. Methodology: Empirical specification-(1)
Our benchmark regression is augmented from RZ’s
specification as
Exporti,k=Σk αkCountryk+ Σi βi Industryi
+ δ1(External financei× Financial developmentk) +εi,k
+ δ2(External financei× Financial sector volatilityk)
+ δ3(External financei× Banking market structurek)
+ Σm θm Other Controlsm,i,k
.
Where subscripts i and k denote the ith industry and kth
country respectively.
2. Methodology: Empirical specification-(1)
Other controls added in specifications (1) include
interaction terms suggested by the trade theory or
empirical studies, which include :

Human capital
Human Capital Intensityi × Human Capital Levelk,1980

Physical capital
Capital Intensityi × Capital Output Ratiok,1980

Resource endowment
Resource intensityi × Natural resource stockk,1984
2. Methodology: Empirical specification-(2)

In addition, firm’s asset may closely relate to financial
development. For instance, Braun (2003) shows that in
countries with lower financial development, industries
with more tangible assets are relatively larger and grow
faster.

Furthermore, this hypothesis has been extended to test the
impact of the interaction between industrial asset
tangibility and financial development of a country on
trade by Hur et al. (2006) and Manova (2008).
2. Methodology: Empirical specification-(2)
Exporti,k =Σk αkCountryk+ Σi βi Industryi
+ δ1(External financei× Financial developmentk) + εi,k
+ δ2(External financei× Financial sector volatilityk)
+ δ3(External financei× Banking market structurek)
+ Σm θm Other Controlsm,i,k
+ γ1(Tangibilityi× Financial developmentk)
+ γ2(Tangibilityi× Financial sector volatilityk)
+ γ3(Tangibilityi× Banking market structurek)
2. Methodology: Empirical concerns (2)


Concern 2: endogeneity
->the shocks that trigger financial sector
volatility can also affect export performance.
Solution: we apply instrumental variable (IV)
technique, using the legal origins of the country
as instruments for financial development or
financial volatility, to estimate the models.
3. Data
The data used in this study mainly obtained from Manova
(2008), Braun (2003) and Beck et al. (2000, 2010).
The full sample contains 63 countries and 27 industries,
for the 1980-1997 period.
The variables are categorized into country-industryspecific, industry-specific and country-specific variables.
(1) Country-Industry-Level variable (i,k)
•Export sharei,k: share of industry i’s export in country k in country k’s
GDP.
3. Data
(2) Industry-Level variable (i)
• External financei: the fraction of investment not financed by
internal funds.
•
Tangibilityi: the ratio of net properties, plant and equipment
to book value of asset.
(3) Country-Level variable (k)
• Private creditk: the ratio of domestic private credit to
GDP in 1980.
• Volatility of private creditk: the standard deviation of
the growth of the private credit over GDP during the 19801997.
• Bank concentrationk: the share of the three largest banks’
assets over all commercial banks averaged over the period
1980-1997.
4. Results: Benchmark results
4. Results: summary for the benchmark results
1. The volatility and concentration of banking industry
respectively exert negative and positive impacts on industrial
exports. Nevertheless, the positive impact of financial
development disappeared when these two financial features
considered. The result is robust to additional controls
considered.
2. The interaction of banking industry volatility with asset
tangibility has statistically positive impact on the relative
exports of industries with more tangible asset, showing that
tangible assets can serve as a collateral to ease access of
finance when confidence in the economy in low.
4. Results: Robustness check (1) -alternative
measures of comparative advantage in trade
4. Results: Robustness check (2)- alternative
measures of volatility in banking industry
4. Results: Robustness check (3)- alternative
measures of market structure
4. Results: Robustness check (4)- developed
countries vs. developing countries
5. Conclusion




The positive effect of financial development on industrial
export via the channel of sectoral external financing is
attenuated when other features of financial sector are
considered.
Financial volatility and banking market structure respectively
exert significantly negative and positive impacts on the export
of industries that are more external financially dependent.
Our finding is robust to a variety of kinds of sensitivity tests.
To sum up, the findings from this study lend support to the
notion that a more stable and concentrated banking system is
important to the exports of those industries that rely more on
external finance, especially so for those developing countries.
~Thank you for your attention~