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Do Banks Affect the Level and Composition of Industrial Volatility?



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    • Borj Larrain is at the Federal Reserve Bank of Boston. This paper is based on the second chapter of my dissertation at Harvard University. An earlier working paper version circulated under the title “Financial Development, Financial Constraints and the Volatility of Industrial Output (2004)” I thank my thesis advisors John Campbell, Andrei Shleifer, and Jeremy Stein for their support and guidance throughout this project. I also thank Matías Braun, Miklós Koren, Krishna Kumar, John Matsusaka, Robert Stambaugh (the editor), Gustavo Suárez, Adam Szeidl, Francesco Trebbi, Motohiro Yogo, an associate editor, an anonymous referee, and seminar participants at the Federal Reserve Bank of Boston, Harvard University, IESE, Ohio State University, the University of Michigan, and the University of Southern California for helpful comments. All errors are my own. The views expressed here are not necessarily those of the Federal Reserve Bank of Boston or the Federal Reserve System.


In theory, better access to bank credit can reduce or increase output volatility depending on whether firms are more financially constrained during contractions or expansions. This paper finds that the volatility of industrial output is lower in countries with more bank credit. Most of the reduction in volatility is idiosyncratic, which follows from the ability of banks to pool and diversify shocks. Systematic volatility is reduced less strongly. Volatility dampening is achieved via countercyclical borrowing: At the firm level, short-term borrowing is less (or more negatively) correlated with sales and inventories in countries with high levels of bank credit.

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