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Innovations, rents and risk


  • Bruno Biais


  • Jean-Charles Rochet


  • Paul Woolley



We offer a rational expectations model of the dynamics of innovative industries. The fundamental value of innovations is uncertain and one must learn whether they are solid or fragile. Also, when the industry is new, it is difficult to monitor managers and make sure they exert the effort necessary to reduce default risk. This gives rise to moral hazard. In this context, initial successes spur optimism and growth. But increasingly confident managers end up requesting large rents. If these become too high, investors give up on incentives, and default risk rises. Thus, moral hazard gives rise to endogenous crises and fat tails in the distribution of aggregate default risk. We calibrate our model to fit the stylized facts of the MBS industry’s boom and bust cycle.

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  • Bruno Biais & Jean-Charles Rochet & Paul Woolley, 2010. "Innovations, rents and risk," FMG Discussion Papers dp659, Financial Markets Group.
  • Handle: RePEc:fmg:fmgdps:dp659

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    References listed on IDEAS

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    Cited by:

    1. Monnet, Cyril & Quintin, Erwan, 2017. "Limited disclosure and hidden orders in asset markets," Journal of Financial Economics, Elsevier, vol. 123(3), pages 602-616.

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