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Financial Markets, Development and Economic Growth: Tales of Informational Asymmetries

The development of financial systems is very often characterised by the development of innovative financial contracts which allow a more efficient allocation of resources and a higher level of capital productivity and economic growth. By exploiting the microeconomic theory of the optimal financial contract under asymmetric information, economists have recently managed to shed new light on the well studied issue of the relationship between financial market development and economic growth. This paper reviews the most recent progress of this literature which shows that the amount of information asymmetry in the credit market and the degree of heterogeneity between borrowers "typically firms" and lenders "typically workers or savers" determine the nature of the financial system. Differences in endowments and in the level of information distribution can give rise to very different financial contracts which affect, and in turn are affected, by capital accumulation and growth. Copyright Blackwell Publishers Ltd, 2004.