Financial Innovation, Market Participation and Asset Prices

Laurent Calvet, Martin Gonzalez-Eiras and Paolo Sodini

No 1928, Harvard Institute of Economic Research Working Papers from Harvard - Institute of Economic Research

Abstract: This paper proposes that the introduction of non-redundant assets can endogenously modify trader participation in financial markets, which can lead to a lower market premium and a higher interest rate. We demonstrate this mechanism in a tractable exchange economy with endogenous participation. Investors receive heterogeneous random incomes determined by a finite number of macroeconomic factors. They can freely borrow and lend, but must pay a fixed entry cost to invest in risky assets. Security prices and the participation structure are jointly determined in equilibrium. The model reconciles a number of features that have characterized financial markets in the past three decades: substantial financial innovation; a sharp increase in investor participation; improved risk management practices; an increase in interest rates; and a reduction in the risk premium.

Date: 2001
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Related works:
Journal Article: Financial Innovation, Market Participation, and Asset Prices (2004)
Working Paper: Financial Innovation, Market Participation, and Asset Prices (2004)
Working Paper: Financial Innovation, Market Participation, and Asset Prices (2004)
Working Paper: Financial Innovation, Market Participation and Asset Prices (2003)
Working Paper: Financial Innovation, Market Participation and Asset Prices (2001)
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