Innovations, rents and risk
AbstractWe offer a rational expectations model of the dynamics of innovative industries. The fundamental value of innovations is uncertain and one must learn whether they are solid or fragile. Also, when the industry is new, it is difficult to monitor managers and make sure they exert the effort necessary to reduce default risk. This gives rise to moral hazard. In this context, initial successes spur optimism and growth. But increasingly confident managers end up requesting large rents. If these become too high, investors give up on incentives, and default risk rises. Thus, moral hazard gives rise to endogenous crises and fat tails in the distribution of aggregate default risk. We calibrate our model to fit the stylized facts of the MBS industry’s boom and bust cycle.
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Bibliographic InfoPaper provided by Financial Markets Group in its series FMG Discussion Papers with number dp659.
Date of creation: Sep 2010
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Other versions of this item:
- Biais, Bruno & Rochet, Jean-Charles & Woolley, Paul, 2010. "Innovations, Rents and Risk," IDEI Working Papers 644, Institut d'Économie Industrielle (IDEI), Toulouse.
- Bruno Biais & Jean-Charles Rochet & Paul Woolley, 2012. "Innovations, rents and risk," DNB Working Papers 356, Netherlands Central Bank, Research Department.
- Biais, Bruno & Rochet, Jean-Charles & Woolley, Paul, 2010. "Innovations, Rents and Risk," TSE Working Papers 10-200, Toulouse School of Economics (TSE).
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