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The Choice Channel of Financial Innovation

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  • Felipe S. Iachan
  • Plamen T. Nenov
  • Alp Simsek

Abstract

Financial innovations in recent decades have vastly expanded investors' portfolio choice. We theoretically analyze the effect of these developments on investors' savings and asset returns. In our model, investors with possibly heterogeneous beliefs choose their savings portfolios. Under mild assumptions, we establish a choice channel by which greater portfolio choice increases investors' (perceived) return from saving, and induces them to save more. We then investigate the asset pricing implications of the choice channel, which depend on the type of financial innovation. Our main result shows that greater customization, which we capture with improved ability to trade risky assets other than the market portfolio, reduces the expected return on every asset. This result is consistent with the decline in the risk-free interest rate since the early 1980s, and is in contrast with the "precautionary savings" literature that would make the opposite prediction. Greater participation, which we capture with improved ability to trade the market portfolio, reduces the risk premia but typically increases the risk-free rate. We also analyze the effect of greater securitization, which we capture with a relaxation of constraints to issue risk-free promises in an environment in which there is a high demand for safe assets.

Suggested Citation

  • Felipe S. Iachan & Plamen T. Nenov & Alp Simsek, 2015. "The Choice Channel of Financial Innovation," NBER Working Papers 21686, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:21686
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    Cited by:

    1. Patir, Assaf, 2017. "Securitization, bank vigilance, leverage and sudden stops," MPRA Paper 81463, University Library of Munich, Germany.
    2. Vladimir Asriyan & Luca Fornaro & Alberto Martin & Jaume Ventura, 2016. "Monetary policy for a bubbly world," Economics Working Papers 1533, Department of Economics and Business, Universitat Pompeu Fabra.
    3. Martin Guzman & Joseph E. Stiglitz, 2016. "Pseudo-wealth and Consumption Fluctuations," NBER Working Papers 22838, National Bureau of Economic Research, Inc.

    More about this item

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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