Rents, learning and risk in the financial sector and other innovative industries

Bruno Biais, Jean Rochet and Paul Woolley

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: We study innovative industries subject to two risks. First, it is uncertain whether the innovation is strong or fragile. Second, it is difficult to monitor managers, which creates moral hazard and agency rents. As time goes by and profits are observed, beliefs about the industry are updated. As long as no default occurs, confidence builds up. Initially this spurs growth. But increasingly confident managers end up requesting large rents, curbing the growth of the industry. If rents become too high, investors give up on incentives, and failure rates rise. If the innovation is fragile, eventually there is a crisis. Our model captures stylized facts of the recent financial innovation wave and generates new implications for risks, returns and rents.

Keywords: innovative industry; financial sector; learning; moral hazard; rents; boom; crisis (search for similar items in EconPapers)
JEL-codes: G12 (search for similar items in EconPapers)
Pages: 40 pages
Date: 2009-09-01
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Related works:
Working Paper: Rents, learning and risk in the financial sector and other innovative industries (2009)
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