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The Implications of Financial Innovation for Capital Markets and Household Welfare

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  • Buss, Adrian
  • Vilkov, Grigory
  • Uppal, Raman

Abstract

Our objective is to understand how financial innovation affects investors' optimal asset-allocation decisions and the economic mechanisms through which these decisions influence financial markets, welfare, and wealth inequality. We show that when some investors, such as households, are less confident than other investors about the dynamics of the new asset made available by financial innovation, but learn over time, many ''intuitive'' results are reversed: financial innovation increases the return volatility and risk premium of the new asset along with volatilities of investors' portfolios. Despite the increase in volatilities, financial innovation improves the welfare of all investors but worsens wealth inequality because experienced investors benefit more from it.

Suggested Citation

  • Buss, Adrian & Vilkov, Grigory & Uppal, Raman, 2018. "The Implications of Financial Innovation for Capital Markets and Household Welfare," CEPR Discussion Papers 13137, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:13137
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    More about this item

    Keywords

    Household finance; Household portfolio choice; Wealth inequality; Differences in beliefs; Parameter uncertainty; Recursive utility; Bayesian learning;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets

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