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Financial Innovation, Market Participation, and Asset Prices

Author

Listed:
  • Laurent-Emmanuel Calvet

    (Department of Economics, Harvard University - Harvard University, Department of Finance, Stern School of Business - Stern School of Business)

  • Martin Gonzales-Eiras

    (Departamento de Economía, Universidad de San Andrés - UMSA - Universidad Mayor de San Andrés)

  • Paolo Sodini

    (SSE - Stockholm School of Economics)

Abstract

This paper investigates the pricing effects of financial innovation in an economy with endogenous participation and heterogeneous income risks. The introduction of non-redundant assets endogenously modifies the participation set, reduces the covariance between dividends and participants' consumption and thus leads to lower risk premia. In multisector economies, financial innovation spreads across markets through the diversified portfolio of new entrants, and has rich effects on the cross-section of expected returns. The price changes can also lead some investors to leave the markets and give rise to non-degenerate forms of participation turnover. The model is consistent with several features of financial markets over the past few decades: substantial innovation, higher participation, significant turnover in investor composition, improved risk management practices, a slight increase in real interest rates, and a reduction in risk premia.

Suggested Citation

  • Laurent-Emmanuel Calvet & Martin Gonzales-Eiras & Paolo Sodini, 2004. "Financial Innovation, Market Participation, and Asset Prices," Post-Print hal-00478480, HAL.
    • Handle: RePEc:hal:journl:hal-00478480
    DOI: 10.1017/S0022109000003975
    as

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    Keywords

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    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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