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Rents, learning and risk in the financial sector and other innovative industries

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  • Biais, Bruno
  • Rochet, Jean-Charles
  • Woolley, Paul

Abstract

We study innovative industries subject to two risks. First, it is uncertain whether the innovation is strong or fragile. Second, it is difficult to monitor managers, which creates moral hazard and agency rents. As time goes by and profits are observed, beliefs about the industry are updated. As long as no default occurs, confidence builds up. Initially this spurs growth. But increasingly confident managers end up requesting large rents, curbing the growth of the industry. If rents become too high, investors give up on incentives, and failure rates rise. If the innovation is fragile, eventually there is a crisis. Our model captures stylized facts of the recent financial innovation wave and generates new implications for risks, returns and rents.

Suggested Citation

  • Biais, Bruno & Rochet, Jean-Charles & Woolley, Paul, 2009. "Rents, learning and risk in the financial sector and other innovative industries," LSE Research Online Documents on Economics 24417, London School of Economics and Political Science, LSE Library.
  • Handle: RePEc:ehl:lserod:24417
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    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Blogs review: What's finance for?
      by in Bruegel blog on 2012-03-23 20:06:46

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    Cited by:

    1. Thakor, Anjan V., 2012. "Incentives to innovate and financial crises," Journal of Financial Economics, Elsevier, vol. 103(1), pages 130-148.
    2. Oh, Frederick Dongchuhl, 2013. "Contagion of a liquidity crisis between two firms," Journal of Financial Economics, Elsevier, vol. 107(2), pages 386-400.
    3. Ron Bird & Harry Liem & Susan Thorp, 2014. "Infrastructure: Real Assets and Real Returns," European Financial Management, European Financial Management Association, vol. 20(4), pages 802-824, September.
    4. Sylvain Champonnois, 2011. "The limits of market discipline: proprietary trading and aggregate risk," 2011 Meeting Papers 1013, Society for Economic Dynamics.
    5. Song, Fenghua & Thakor, Anjan, 2022. "Ethics, capital and talent competition in banking," Journal of Financial Intermediation, Elsevier, vol. 52(C).

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    More about this item

    Keywords

    innovative industry; financial sector; learning; moral hazard; rents; boom; crisis;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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