Discussion Paper Details

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Title: Investor Protection and Income Inequality: Risk Sharing vs Risk Taking

Author(s): Alessandra Bonfiglioli

Publication Date: June 2010

Keyword(s): income inequality, investor protection, optimal financial contracts, risk sharing and risk taking

Programme Area(s): International Macroeconomics

Abstract: This paper studies the relationship between investor protection, entrepreneurial risk taking and income inequality. In the presence of market frictions, better protection makes investors more willing to take on entrepreneurial risk when lending to firms, thereby improving the degree of risk sharing between financiers and entrepreneurs. On the other hand, by increasing risk sharing, investor protection also induces more firms to undertake risky projects. By increasing entrepreneurial risk taking, it raises income dispersion. By reducing the risk faced by entrepreneurs, it reduces income volatility. As a result, investor protection raises income inequality to the extent that it fosters risk taking, while it reduces it for a given level of risk taking. Empirical evidence from a panel of forty-five countries spanning the period 1976-2000 supports the predictions of the model.

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Bibliographic Reference

Bonfiglioli, A. 2010. 'Investor Protection and Income Inequality: Risk Sharing vs Risk Taking'. London, Centre for Economic Policy Research.