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Financial Innovation, Market Participation and Asset Prices

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  • Laurent Calvet
  • Martin Gonzalez-Eiras
  • Paolo Sodini

Abstract

This paper investigates the pricing effects of financial innovation in an economy with endogenous participation and heterogeneous income risks. The introduction of non-redundant assets endogenously modifies the participation set, reduces the covariance between dividends and participants' consumption and thus leads to lower risk premia. In multisector economies, financial innovation spreads across markets through the diversified portfolio of new entrants, and has rich effects on the cross-section of expected returns. The price changes can also lead some investors to leave the markets and give rise to non-degenerate forms of participation turnover. The model is consistent with several features of financial markets over the past few decades: substantial innovation; higher participation; significant turnover in investor composition; improved risk management practices; a slight increase in interest rates; and a reduction in risk premia.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9840.

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Date of creation: Jul 2003
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Publication status: published as Calvet, Laurent, Martin Gonzalez-Eiras and Paolo Sodini. "Financial Innovation, Market Participation, And Asset Prices," Journal of Financial and Quantitative Analysis, 2004, v39(3,Sep), 431-459.
Handle: RePEc:nbr:nberwo:9840

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