Natural Catastrophes and Financial Development

• Thesis title in Czech: Přírodní katastrofy a finanční rozvoj
• Thesis title in English: Natural Catastrophes and Financial Development
• Key words: Přírodní katastrofy, Finanční rozvoj, Finanční hloubka, Finanční efektivita, Přístup k financím, Finanční stabilita
• English key words: Natural disasters, Financial development, Financial depth, Financial efficiency, Financial access, Financial stability
• Academic year of topic announcement: 2020/2021
• Thesis type: diploma thesis
• Thesis language: angličtina
• Department: Institute of Economic Studies (23-IES)
• Supervisor: prof. Roman Horváth, Ph.D.
• Author: hidden - assigned by the advisor
• Date of registration: 17.06.2021
• Date of assignment: 17.06.2021
• Date and time of defence: 01.02.2023 09:00
• Venue of defence: Opletalova - Opletalova 26, O206, Opletalova - místn. č. 206
• Date of electronic submission: 30.12.2022
• Date of proceeded defence: 01.02.2023
• Opponents: doc. PhDr. Ing. et Ing. Petr Jakubík, Ph.D., Ph.D.

References

Botzen, W.J.W., Deschenes, O., Sanders, M., 2019. The economic impacts of natural disasters: a review of models and empirical studies. Rev. Environ. Econ. Policy13 (2), 167–188.

Čihák, M., Demirguc-Kunt, A., Feyen, E., Levine, R., 2013. Financial Development in 205 Economies, 1960 to 2010. National Bureau of Economic Research, Working Paper 18946.

Horváth, R., 2021. Natural catastrophes and financial depth: An empirical analysis. Journal of Financial Stability, 53, 100842.

Keerthiratne, W., Tol, R., 2017. Impact of natural disasters on financial development. Econ. Disasters Clim. Change 1, 33–54.

Loayza, N.V., Olaberria, E., Rigolini, J., Christiaensen, L., 2012. Natural disasters and growth: going beyond the averages. World Dev. 40 (7), 1317–1336.

McDermott, T., Barry, F., Tol, R., 2014. Disasters and development: Natural disasters, credit constraints, and economic growth, 66. Oxford Economic Papers, pp. 750–773.

Melecky, M., Raddatz, C., 2015. Fiscal responses after catastrophes and the enabling role of financial development. World Bank Econ. Rev. 29, 129–149.

Preliminary scope of work

Motivation:
Natural catastrophes claim many lives every year, inflict tremendous costs, and their consequences can be devastating. Therefore, it is desirable to fully understand effects of natural disasters from the economists’ point of view, and devise policies to mitigate their negative impact. Unfortunately, it is predicted that the number of natural catastrophes will only increase in the future due to the ongoing climate change and more intense economic activity (Botzen et al., 2019). Moreover, developing countries are affected by disasters more heavily than the developed ones (Loayza et al., 2012).

Little has been studied about the effect of natural disasters on the financial development of countries empirically so far. Even in theory, there is no clear consensus about the effects, and the predictions differ mainly for developing and developed countries. On one hand, mature financial markets can diminish the negative consequences by extending more credit to private and public sector (Melecky and Raddatz, 2015); but on the other hand, less developed financial institutions can become more unstable and thus the access to finance might be restricted. Furthermore, government expenditures and foreign aid can potentially crowd out the private investment (Melecky and Raddatz, 2015).

Horváth (2021) already studied the effect of large natural catastrophes on financial depth as one of the components of financial development. Using synthetic control method, he found that credit to GDP ratio persists about 30% below its counterfactual even ten years after a catastrophe occurred, and thus the impact of natural disasters on financial depth measured by the private credit to GDP ratio is not negligible. Nevertheless, Keerthiratne and Tol (2017) came to different findings. According to their analysis, natural catastrophes in fact increase financial development, mainly in developing countries. Thus, the evidence on the effect of natural disasters on financial development is mixed so far.


Hypotheses:
1. Hypothesis #1: Natural catastrophes have a significant negative effect on financial development, and this effect is stronger in developing countries.
2. Hypothesis #2: Some types of a natural disasters (such as biological) matter more in affecting financial development.
3. Hypothesis #3: The strength of the impact of natural catastrophes is different for each measure of financial development.


Methodology:
For the empirical analysis, I will use the fixed effects panel data model to account for the unobserved heterogeneity. There is likely to be an endogeneity problem since it is wrong to assume that natural disasters are completely exogenous shocks. Countries can take some precautionary measures to reduce potential negative consequences of a disaster, and developed countries are more inclined to do so. Natural disasters also occur more often in the developing world, and lower income countries tend to be more oriented on the agriculture which is highly reliant on the weather (McDermott et al., 2014).

I will hence examine the differences between the effects of natural disasters on the various indicators of financial development in both developed and developing countries. Emphasis will be put also on the impact of different types of natural catastrophes.

A comprehensive global database of natural catastrophes that I will use is called EM-DAT from the Centre for Research on the Epidemiology of Disaster (CRED), Université Catholique de Louvain. It consists of all natural catastrophes from 1900 until the present day that fulfil some predefined criteria (such as some number of people killed or affected must be exceeded) and includes economic, human, and geographical information on the country level. Data on the financial development are available from the Global Financial Development Database operated by the World Bank. It is based on a 4x2 framework, and contains indicators of stability, access, depth and efficiency of financial systems for both financial institutions and financial markets (Čihák et al., 2013). Unfortunately, the availability of some measures is limited, mainly regarding the time coverage, and thus my analysis will have to be adjusted accordingly.


Expected Contribution:
The aim of this diploma thesis is to contribute to the narrow empirical literature on the effect of natural disasters on financial development. In contrast to few previous studies, I will emphasize also measures of financial development other than financial depth. Even though I will be limited by the time coverage of those measures, the covered time period is longer than for the previous studies, and the dataset will include also more current natural disasters than the works of my predecessors. Keerthiratne and Tol (2017) used the fixed effects panel data model as well but they did not use the private credit to GDP ratio which is the most common indicator of financial depth. Therefore, I will work with this measure in my analysis as it is the most relevant measure of financial depth. I will stress the impact of different types of natural disasters as well. My findings can be useful for policymakers when deciding about appropriate policies in order to mitigate adverse impacts of natural catastrophes on financial development.


Outline:
1. Introduction – I will motivate my topic and discuss why it is important to study.
2. Literature review – I will review the existing literature on the effects of natural catastrophes on economy and financial markets, as well as some works related to the financial development in general.
3. Data description – I will briefly describe the data used.
4. Methodology – I will explain the empirical framework that I will use for the analysis.
5. Results – I will discuss the results of my empirical analysis.
6. Conclusion – I will summarize my key findings and propose some policy implications.