Schumpeterian Entrepreneur meets Schumpeterian Banker: Growth with Heterogeneous Risk Aversion

Speaker:  Dr Axel Wieneke

Affiliation: The University of Queensland

Location: Level 6 Boardroom (629), Colin Clark Building (#39), St Lucia Campus

Abstract: Innovation is a key driver of economic growth, but it is inherently risky and requires financiers willing to assume this risk. This paper incorporates the risk-transformation role of banks into an endogenous growth model. The model shows that heterogeneous risk aversion alone can explain several real-world phenomena in growth and finance. In the model agents differing in their degrees of risk aversion trade financial risk, resulting in both bank and market finance coexisting, even in the absence of transaction costs. A larger dispersion in risk aversion leads to a higher share of bank financing and, all else equal, a lower steady state growth rate. A negative shock, such as a failed innovation, impacts bank equity overproportionatelly, causing a temporary widening of the interest rate spread. Despite increased bank leverage and profitability following such a shock, rebuilding lost equity capital takes time, which helps explain the prolonged periods of low wage growth typically observed after a banking crisis.