The Lifecycle of the Financial Sector and Other Speculative Industries
AbstractSpeculative industries exploit novel technologies subject to two risks. First, there is uncertainty about the fundamental value of the innovation: is it strong or fragile? Second, it is difficult to monitor managers, which creates moral hazard. Because of moral hazard, managers earn agency rents in equilibrium. As time goes by and profits are observed, beliefs about the industry are rationally updated. If the industry is strong, confidence builds up. Initially this spurs growth. But increasingly confident managers end up requesting very large rents, which curb the growth of the speculative sector. If rents become too high, investors may give up on incentives, and risk and failure rates rise. Furthermore, if the innovation is fragile, eventually there is a crisis, and the industry shrinks. Our model thus captures important stylized facts of the financial innovation wave which took place at the beginning of this century.
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Bibliographic InfoPaper provided by Toulouse School of Economics (TSE) in its series TSE Working Papers with number 09-031.
Date of creation: Apr 2009
Date of revision:
Other versions of this item:
- Biais, Bruno & Rochet, Jean-Charles & Woolley, Paul, 2009. "The Lifecycle of the Financial Sector and Other Speculative Industries," IDEI Working Papers 549, Institut d'Économie Industrielle (IDEI), Toulouse.
- NEP-ALL-2010-05-22 (All new papers)
- NEP-BAN-2010-05-22 (Banking)
- NEP-BEC-2010-05-22 (Business Economics)
- NEP-CTA-2010-05-22 (Contract Theory & Applications)
- NEP-TID-2010-05-22 (Technology & Industrial Dynamics)
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