IDEAS home Printed from https://ideas.repec.org/p/bge/wpaper/502.html
   My bibliography  Save this paper

Neglected Risks, Financial Innovation, and Financial Fragility

Author

Listed:
  • Nicola Gennaioli
  • Andrei Shleifer
  • Robert Vishny

Abstract

We present a standard model of financial innovation, in which intermediaries engineer securities with cash flows that investors seek, but modify two assumptions. First, investors (and possibly intermediaries) neglect certain unlikely risks. Second, investors demand securities with safe cash flows. Financial intermediaries cater to these preferences and beliefs by engineering securities perceived to be safe but exposed to neglected risks. Because the risks are neglected, security issuance is excessive. As investors eventually recognize these risks, they fly back to safety of traditional securities and markets become fragile, even without leverage, precisely because the volume of new claims is excessive.

Suggested Citation

  • Nicola Gennaioli & Andrei Shleifer & Robert Vishny, 2010. "Neglected Risks, Financial Innovation, and Financial Fragility," Working Papers 502, Barcelona School of Economics.
    • Handle: RePEc:bge:wpaper:502
    as

    Download full text from publisher

    File URL: http://www.barcelonagse.eu/sites/default/files/working_paper_pdfs/502.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "Varieties of Crises and Their Dates," Introductory Chapters, in: This Time Is Different: Eight Centuries of Financial Folly, Princeton University Press.
    2. Acharya, Viral V. & Cooley, Thomas & Richardson, Matthew & Walter, Ingo, 2010. "Manufacturing Tail Risk: A Perspective on the Financial Crisis of 2007–2009," Foundations and Trends(R) in Finance, now publishers, vol. 4(4), pages 247-325, April.
    3. Shleifer, Andrei & Vishny, Robert W, 1992. "Liquidation Values and Debt Capacity: A Market Equilibrium Approach," Journal of Finance, American Finance Association, vol. 47(4), pages 1343-1366, September.
    4. Shleifer, Andrei & Vishny, Robert W., 2010. "Unstable banking," Journal of Financial Economics, Elsevier, vol. 97(3), pages 306-318, September.
    5. Marcin Kacperczyk & Philipp Schnabl, 2010. "When Safe Proved Risky: Commercial Paper during the Financial Crisis of 2007-2009," Journal of Economic Perspectives, American Economic Association, vol. 24(1), pages 29-50, Winter.
    6. Kristopher Gerardi & Andreas Lehnert & Shane M. Sherlund & Paul Willen, 2008. "Making Sense of the Subprime Crisis," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 39(2 (Fall)), pages 69-159.
    7. repec:rnp:ecopol:09111 is not listed on IDEAS
    8. Dekel, Eddie & Lipman, Barton L. & Rustichini, Aldo, 1998. "Recent developments in modeling unforeseen contingencies," European Economic Review, Elsevier, vol. 42(3-5), pages 523-542, May.
    9. Tobias Adrian & Adam B. Ashcraft & Hayley Boesky & Zoltan Pozsar, 2013. "Shadow banking," Economic Policy Review, Federal Reserve Bank of New York, issue Dec, pages 1-16.
      • Tobias Adrian & Adam B. Ashcraft & Hayley Boesky & Zoltan Pozsar, 2010. "Shadow banking," Staff Reports 458, Federal Reserve Bank of New York.
    10. Atif Mian & Amir Sufi, 2009. "The Consequences of Mortgage Credit Expansion: Evidence from the U.S. Mortgage Default Crisis," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 124(4), pages 1449-1496.
    11. Stephen A. Ross, 1976. "Options and Efficiency," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 90(1), pages 75-89.
    12. Douglas W. Diamond & Raghuram G. Rajan, 2009. "Fear of Fire Sales and the Credit Freeze," NBER Working Papers 14925, National Bureau of Economic Research, Inc.
    13. Benjamin J. Keys & Tanmoy Mukherjee & Amit Seru & Vikrant Vig, 2010. "Did Securitization Lead to Lax Screening? Evidence from Subprime Loans," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 125(1), pages 307-362.
    14. Raghuram G. Rajan, 2006. "Has Finance Made the World Riskier?," European Financial Management, European Financial Management Association, vol. 12(4), pages 499-533, September.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Nicola Gennaioli & Andrei Shleifer & Robert Vishny, 2010. "Financial Innovation and Financial Fragility," Working Papers 2010.114, Fondazione Eni Enrico Mattei.
    2. Gennaioli, Nicola & Shleifer, Andrei & Vishny, Robert, 2012. "Neglected risks, financial innovation, and financial fragility," Journal of Financial Economics, Elsevier, vol. 104(3), pages 452-468.
    3. Nicola Gennaioli & Andrei Shleifer & Robert W. Vishny, 2013. "A Model of Shadow Banking," Journal of Finance, American Finance Association, vol. 68(4), pages 1331-1363, August.
    4. Ing-Haw Cheng & Sahil Raina & Wei Xiong, 2014. "Wall Street and the Housing Bubble," American Economic Review, American Economic Association, vol. 104(9), pages 2797-2829, September.
    5. Manganelli, Simone & Altunbas, Yener & Marqués-Ibáñez, David, 2011. "Bank risk during the financial crisis: do business models matter?," Working Paper Series 1394, European Central Bank.
    6. Thomas Philippon & Philipp Schnabl, 2013. "Efficient Recapitalization," Journal of Finance, American Finance Association, vol. 68(1), pages 1-42, February.
    7. Daniel Covitz & Nellie Liang & Tobias Adrian, 2015. "Financial Stability Monitoring," Annual Review of Financial Economics, Annual Reviews, vol. 7(1), pages 357-395, December.
    8. Shleifer, Andrei & Vishny, Robert W., 2010. "Unstable banking," Journal of Financial Economics, Elsevier, vol. 97(3), pages 306-318, September.
    9. Pierri, Nicola & Timmer, Yannick, 2022. "The importance of technology in banking during a crisis," Journal of Monetary Economics, Elsevier, vol. 128(C), pages 88-104.
    10. Altunbas, Yener & Manganelli, Simone & Marques-Ibanez, David, 2017. "Realized bank risk during the great recession," Journal of Financial Intermediation, Elsevier, vol. 32(C), pages 29-44.
    11. Deniz Igan & Prachi Mishra & Thierry Tressel, 2012. "A Fistful of Dollars: Lobbying and the Financial Crisis," NBER Macroeconomics Annual, University of Chicago Press, vol. 26(1), pages 195-230.
    12. Tobias Adrian & Nellie Liang, 2018. "Monetary Policy, Financial Conditions, and Financial Stability," International Journal of Central Banking, International Journal of Central Banking, vol. 14(1), pages 73-131, January.
    13. Ozlem Akin & José Montalvo & Jaume García Villar & José-Luis Peydró & Josep Raya, 2014. "The real estate and credit bubble: evidence from Spain," SERIEs: Journal of the Spanish Economic Association, Springer;Spanish Economic Association, vol. 5(2), pages 223-243, August.
    14. Atif Mian & Amir Sufi & Francesco Trebbi, 2015. "Foreclosures, House Prices, and the Real Economy," Journal of Finance, American Finance Association, vol. 70(6), pages 2587-2634, December.
    15. Daniel García, 2020. "Employment in the Great Recession: How Important Were Household Credit Supply Shocks?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 52(1), pages 165-203, February.
    16. Andrei Shleifer & Robert Vishny, 2011. "Fire Sales in Finance and Macroeconomics," Journal of Economic Perspectives, American Economic Association, vol. 25(1), pages 29-48, Winter.
    17. Tobias Adrian & Adam B. Ashcraft, 2012. "Shadow Banking Regulation," Annual Review of Financial Economics, Annual Reviews, vol. 4(1), pages 99-140, October.
    18. Ebrahimi Kahou, Mahdi & Lehar, Alfred, 2017. "Macroprudential policy: A review," Journal of Financial Stability, Elsevier, vol. 29(C), pages 92-105.
    19. Rhys Bidder & John Krainer & Adam Shapiro, 2021. "De-leveraging or de-risking? How banks cope with loss," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 39, pages 100-127, January.
    20. Gabriel Jiménez & Steven Ongena & José‐Luis Peydró & Jesús Saurina, 2014. "Hazardous Times for Monetary Policy: What Do Twenty‐Three Million Bank Loans Say About the Effects of Monetary Policy on Credit Risk‐Taking?," Econometrica, Econometric Society, vol. 82(2), pages 463-505, March.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bge:wpaper:502. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Bruno Guallar (email available below). General contact details of provider: https://edirc.repec.org/data/bargses.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.