Neglected Risks, Financial Innovation, and Financial Fragility

Nicola Gennaioli, Andrei Shleifer and Robert Vishny

No 16068, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We present a standard model of financial innovation, in which intermediaries engineer securities with cash flows that investors seek, but modify two assumptions. First, investors (and possibly intermediaries) neglect certain unlikely risks. Second, investors demand securities with safe cash flows. Financial intermediaries cater to these preferences and beliefs by engineering securities perceived to be safe but exposed to neglected risks. Because the risks are neglected, security issuance is excessive. As investors eventually recognize these risks, they fly back to safety of traditional securities and markets become fragile, even without leverage, precisely because the volume of new claims is excessive.

JEL-codes: G01 G14 G21 (search for similar items in EconPapers)
Date: 2010-06
Note: AP CF
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Citations: View citations in EconPapers (30)

Published as Gennaioli, Nicola & Shleifer, Andrei & Vishny, Robert, 2012. "Neglected risks, financial innovation, and financial fragility," Journal of Financial Economics, Elsevier, vol. 104(3), pages 452-468.
Published as Neglected Risks, Financial Innovation, and Financial Fragility , Nicola Gennaioli, Andrei Shleifer, Robert Vishny. in Market Institutions and Financial Market Risk , Carey, Kashyap, Rajan, and Stulz. 2012

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Journal Article: Neglected risks, financial innovation, and financial fragility (2012)
Working Paper: Neglected Risks, Financial Innovation, and Financial Fragility (2012)
Chapter: Neglected Risks, Financial Innovation, and Financial Fragility (2010)
Working Paper: Neglected Risks, Financial Innovation, and Financial Fragility (2010)
Working Paper: Neglected risks, financial innovation and financial fragility (2010)
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