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Published online by Cambridge University Press:  15 September 2009

Robert M. Townsend*
Massachusetts Institute of Technology
Sergio S. Urzua
Northwestern University
Address correspondence to: Robert M. Townsend, Elizabeth and James Killian Professor of Economics at MIT and Research Associate at the University of Chicago, 50 Memorial Drive, Cambridge, MA 02142, USA; e-mail:


We study the impact that financial intermediation can have on productivity through the alleviation of credit constraints in occupation choice and/or an improved allocation of risk, using both static and dynamic structural models as well as reduced-form OLS and IV regressions. Our goal in this paper is to bring these two strands of the literature together. Even though, under certain assumptions, IV regressions can accurately recover the true model-generated local average treatment effect, this is quantitatively different, in order of magnitude and even sign, from other policy impact parameters (e.g., ATE and TT). We also show that laying out clearly alternative models can guide the search for instruments. On the other hand, adding more margins of decision, that is, occupation choice and intermediation jointly, or adding more periods with promised utilities as key state variables, as in optimal multiperiod contracts, can cause the misinterpretation of IV as the causal effect of interest.

Copyright © Cambridge University Press 2009

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