Financial Choice in a Non-Ricardian Model of Trade

We join the new trade theory with a model of choice between bank and bond financing to show the differential effects of financial policy on the distribution of firm size, gains from trade, and the real exchange rate in a small open economy. Increasing bank efficiency and reducing bond transaction costs have opposite effects on the extensive margin of trade, aggregate exports, and the real exchange rate. Increasing access to export markets allows firms to overcome high fixed costs of bond issuance to secure a lower marginal cost of capital, reducing prices on their goods sold both at home and abroad – a financial switching channel that is a new source of gains from trade in the Melitz framework