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The dark side of financial innovation: A case study of the pricing of a retail financial product

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  • Henderson, Brian J.
  • Pearson, Neil D.
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    Abstract

    The offering prices of 64 issues of a popular retail structured equity product were, on average, almost 8% greater than estimates of the products' fair market values obtained using option pricing methods. Under reasonable assumptions about the underlying stocks' expected returns, the mean expected return estimate on the structured products is slightly below zero. The products do not provide tax, liquidity, or other benefits, and it is difficult to rationalize their purchase by informed rational investors. Our findings are, however, consistent with the recent hypothesis that issuing firms might shroud some aspects of innovative securities or introduce complexity to exploit uninformed investors.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Financial Economics.

    Volume (Year): 100 (2011)
    Issue (Month): 2 (May)
    Pages: 227-247

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    Handle: RePEc:eee:jfinec:v:100:y:2011:i:2:p:227-247

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    Web page: http://www.elsevier.com/locate/inca/505576

    Related research

    Keywords: Structured products Financial innovation Derivatives Pricing;

    References

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    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    1. Carlin, Bruce I., 2009. "Strategic price complexity in retail financial markets," Journal of Financial Economics, Elsevier, vol. 91(3), pages 278-287, March.
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    Cited by:
    1. Erner, Carsten & Klos, Alexander & Langer, Thomas, 2013. "Can prospect theory be used to predict an investor’s willingness to pay?," Journal of Banking & Finance, Elsevier, vol. 37(6), pages 1960-1973.
    2. Baule, Rainer, 2011. "The order flow of discount certificates and issuer pricing behavior," Journal of Banking & Finance, Elsevier, vol. 35(11), pages 3120-3133, November.
    3. Thorsten Beck & Tao Chen & Chen Lin & Frank M. Song, 2012. "Financial Innovation: The Bright and the Dark Sides," Working Papers 052012, Hong Kong Institute for Monetary Research.
    4. W. Scott Frame & Lawrence J. White, 2014. "Technological Change, Financial Innovation, and Diffusion in Banking," Working Papers 14-02, New York University, Leonard N. Stern School of Business, Department of Economics.
    5. M. Shahid Ebrahim & Seema Makhdoomi & Mustapha Sheikh, 2012. "The Political Economy and the Perennial Underdevelopment of the Muslim World," Working Papers 12011, Bangor Business School, Prifysgol Bangor University (Cymru / Wales).
    6. Kosfeld, Michael & Schüwer, Ulrich, 2014. "Add-on pricing in retail financial markets and the fallacies of consumer education," SAFE Working Paper Series 47, Center of Excellence SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.
    7. Murizah Osman Salleh & Aziz Jaafar & M. Shahid Ebrahim, 2011. "The Inhibition of Usury (Riba An-Nasi'ah) and the Economic Underdevelopment of the Muslim World," Working Papers 11002, Bangor Business School, Prifysgol Bangor University (Cymru / Wales).
    8. Franklin Allen, 2012. "Trends in Financial Innovation and Their Welfare Impact: An Overview," DNB Working Papers 355, Netherlands Central Bank, Research Department.

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