Financial Innovation and Asset Prices

Raman Uppal, Adrian Buss and Grigory Vilkov

No 12416, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We study the effects of financial innovation on the dynamics of asset prices. We show that when some investors are less well informed about the new asset but rationally learn about it, many "intuitive'' results are reversed: financial innovation increases the volatility of investors' portfolios along with the return volatility and risk premium for the new asset, which decline to their pre-innovation levels only slowly. Moreover, illiquidity of the new asset causes shocks to the new asset to spill over to the traditional asset, increasing their return correlation and giving rise to a liquidity premium for the new asset.

Keywords: Differences in beliefs; Parameter uncertainty; Rational learning; Spillover effects; Recursive utility (search for similar items in EconPapers)
JEL-codes: G11 G12 (search for similar items in EconPapers)
Date: 2017-11
New Economics Papers: this item is included in nep-fmk, nep-ino and nep-upt
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Citations: View citations in EconPapers (1)

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