The relationship between deregulation and firm volatility

Firms that depend on the banking sector get wider access to finance after deregulation, according to a paper from the Federal Reserve. ‘Firm volatility and banks: Evidence from US banking deregulation', published in November, finds this to be the case based on evidence from state-level banking deregulation in the 1980s.

The paper shows that firm-level employment, production, sales and cash flows demonstrated reduced volatility after interstate deregulation, especially in the case of firms that had limited access to external means of finance.

It finds that the stabilising effect of deregulation is related to firms' ability to exploit credit in smoothing out idiosyncratic shocks. Using a multifactor model of stock returns, it also shows that the idiosyncratic component of stock volatility declines on the back of deregulation.

The authors argue their results indicate that the increase in long term firm-level volatility that is documented elsewhere could have been steeper in the absence of deregulation.

Click here to read the paper