The Implications of Financial Innovation for Capital Markets and Household Welfare

Adrian Buss, Grigory Vilkov and Raman Uppal

No 13137, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Our objective is to understand how financial innovation affects investors' optimal asset-allocation decisions and the economic mechanisms through which these decisions influence financial markets, welfare, and wealth inequality. We show that when some investors, such as households, are less confident than other investors about the dynamics of the new asset made available by financial innovation, but learn over time, many ''intuitive'' results are reversed: financial innovation increases the return volatility and risk premium of the new asset along with volatilities of investors' portfolios. Despite the increase in volatilities, financial innovation improves the welfare of all investors but worsens wealth inequality because experienced investors benefit more from it.

Keywords: Household finance; Household portfolio choice; Wealth inequality; Differences in beliefs; Parameter uncertainty; Recursive utility; Bayesian learning (search for similar items in EconPapers)
JEL-codes: D53 G11 G12 (search for similar items in EconPapers)
Date: 2018-08
New Economics Papers: this item is included in nep-ino and nep-upt
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