Value at Risk and Economic Growth

By Martin, Miguel-Angel Galindo; Sotos, Francisco Escribano et al. | International Advances in Economic Research, May 2007 | Go to article overview

Value at Risk and Economic Growth


Martin, Miguel-Angel Galindo, Sotos, Francisco Escribano, Picazo, Maria Teresa Mendez, International Advances in Economic Research


Abstract The improvement of data statistics as well as the econometrician methods have facilitated the introduction the new variables and factors I the economic growth analysis. In this sense, real variables have mainly been considered in the economic growth studies, but not financial or risk management aspects. In this sense, it is interesting to analyze the relationship between economic growth and value at risk and the feed-back process. The goal of the paper is to analyze the relationship between economic growth and risk management and the feed-back process. We will consider economic variables, including economic growth, rule of law, human capital, fiscal policy and monetary policy, among others, in our analysis. We will analyze the theoretical relationships between these variables and risk and the effects of risk on economic growth. We will also develop an empirical analysis considering the case of 15 European Union countries.

Keywords economic growth * risk * efficiency * human capital

JEL Classification O10

Introduction

Economic growth theoreticians have been interested to analyze the relationship between country financial structure effects and economic growth. As it is well known, the models developed by Romer (1986, 1987, 1990) and Lucas (1988) among others, determine the mechanisms through which growth rates are endogenously determined by technological factors, intertemporal preferences, market structures and government economic policy. In these kinds of models, it is supposed that the economic agent could invest in two types of investments, safe and risky. In Romer (1990) ongoing growth depends on introducing new and more specialized investment that implies higher risk.

If we accept this assumption, then it is possible to consider that there will be a shift from safe to riskier investments because riskier technologies will have higher returns than the safer ones, creating diversified portfolios of risky investments. As Arrow (1971, p. 137, quoted by Obstfeld, 1994) states, "The possibility of shifting risks, of insurance in the broadest sense, permits individuals to engage in risky activities that they would not otherwise undertake."

In this sense, financial intermediaries play an important role to encourage growth pooling idiosyncratic investment risks and eliminating ex ante uncertainty about rates of return (Greenwood & Jovanovic, 1990). However, it is necessary to take into account as Bencivenga and Smith (1991) point out that the financial intermediaries provide liquidity that could encourage to economic agents to introduce it into relative productivity uses, that is, in those activities that are not necessarily directly connected with production, for example, consumption. This preference for liquid assets would have a negative effect on economic growth.

However, on the other hand riskier countries would be less attractive to investors that would be more interested to carry their funds toward those countries that have developed an efficient market, an adequate rule of law and a deregulation process, although the returns are lower. Therefore, we can conclude like Devereux and Smith (1994) that risk reduction may retard or promote economic growth, depending on the assumptions considered. Risky investments are accepted when there is a high confidence that there will be high future returns. And economic growth process helps to achieve this confidence. If there is any kind of lag or not sufficient growth to create such confidence, investors would shift their funds from risky activities to safer ones.

The main goal of our paper is to consider the relationship between risk and economic growth from a theoretical and empirical point of view. In the next section, risk concept will be considered. In the following section, the relationship between risk and economic growth is introduced considering the possibility of a feedback effect. Then, the empirical study is developed considering the case of 15 European Union countries. …

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