Financial Innovation and Asset Price Volatility
We compare asset prices in an overlapping generations model for incomplete and complete markets. Individuals within a generational cohort have heterogeneous beliefs about future states of the economy and thus would like to make bets against each other. In the incomplete-markets economy, agents cannot make such bets. Asset price volatility is very small. The situation changes dramatically when markets are completed through financial innovations as the set of available securities now allows agents with different beliefs to place bets against each other. Wealth shifts across agents and generations. Such changes in the wealth distribution lead to substantial asset price volatility.
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Volume (Year): 102 (2012)
Issue (Month): 3 (May)
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- Huffman, Gregory W, 1987. "A Dynamic Equilibrium Model of Asset Prices and Transaction Volume," Journal of Political Economy, University of Chicago Press, vol. 95(1), pages 138-59, February.
- Shafiqur Rahman, 2001. "The Introduction of Derivatives on the Dow Jones Industrial Average and Their Impact on the Volatility of Component Stocks," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 21(7), pages 633-653, 07.
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