Financial development and industry diversification

Abstract

This paper empirically and theoretically studies industry or sec- tor diversication as a determinant to nancial development. The empirical evidence nds evidence that there is a robust relationship between industry (or sector) diversication and nancial development. The theoretical model explains these results by modeling the endoge- nous development of the nancial system as a result of industry (or sector) diversication. An economy with more sectors (industry di- versication) imply a greater opportunity for diversifying lending risk and thus a reduction in the aggregate risk of the nancial system. This reduction in the aggregate risk of the nancial system is what de- termines nancial development. The policy implications are that the government should promote the creation of new industrial sectors by subsidizing R&D and horizontal innovation