Working Paper Series: Special Edition of 2016 to 2018 Interns

Pearson (2010) 14 show that financial institutions engineered financial products that exploited uninformed investors.

4.0 Data and Methodology The data collected for this paper was obtained through the Eastern Caribbean Central Bank’s database and the World Bank. This paper used panel data for seven (7) ECCU countries for the period 2004-2016. The sample does not include prior years due to lack of data for variables used to measure financial innovation. The data was analysed using Stata-14. 4.1 Methodology This study employed the extended Aghion, Howitt, and Mayer-Foulkes (AHM) Model developed by Laeven, Levine & Michalopoulos (2012). A key feature of their model was that, despite the level of financial development, without financial innovation economies will not grow. Let’s first consider the AHM cross-country regression framework: − 1 = b 0 + b 1 F + b 2 (y − y 1 ) + b 3 F(y − y 1 ) + b 4 X + u (1) where g−g 1 is average growth rate of per capita income relative to U.S. growth over the period 1960-95, F is financial development in 1960, which is measured as credit to the private sector as a share of GDP, y − y 1 is log of per capita income relative to US per capita income, X is set of control variables, and u is an error term. AHM estimate this regression model using cross-sectional data on 63 countries over the period 1960-1995. In contrast to AHM, the extended AHM model stresses the importance of financial innovation, not financial development. Indeed, in their model the level of financial development in any period is an outcome of previous financial innovations. Building on the model above, Laeven et al (2012) amend the AHM regression framework as follows: g i,t − g 1i,t = b 0 + b 1 F i,t + b 2 (y i,t − y 1i,t ) + b 3 F i,t (y i,t − y 1i,t ) + b 4 X i,t + b 5 f i,t + b 6 f i,t (y i,t − y 1i,t ) + δ i + µ i,t (2) Where t indicates the particular period, so that t = 1,2,...7, for each country i, data permitting, δt is the coefficient on a country-specific effect, and where they also control for a time-specific effect in each period in the panel. This study estimates a reduced form of equation (2) by dropping

14 Cited in (Laeven, et al., 2015)

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