Financial Innovation and Portfolio Risks
American Economic Review · 2013 · Volume 103 · Issue 3
Abstract
I illustrate the effect of financial innovation on portfolio risks by using an example with risk-sharing needs and belief disagreements. I consider two types of innovation: product innovation, formalized as an expansion of new financial assets; and process innovation, formalized as a reduction in transaction costs. When belief disagreements are large, both types of innovation increase portfolio risks. Moreover, endogenous financial innovation is directed towards speculative assets that increase portfolio risks.
Keywords
Portfolio Choice, Investment Decisions, Asset Pricing, Trading volume, Bond Interest Rates
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