Financial Innovation, Market Participation, and Asset Prices

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This paper investigates the pricing effects of financial innovation in an economy with endogenous participation and heterogeneous income risk. The introduction of non-redundant assets endogenously modifies the participation set, reduces the covariance between dividends and participants' consumption and thus leads to lower risk premia. In multisector economies, financial innovation spreads accross markets through the diversified portfolio of new entrants, and has rich effects on the cross-section of expected returns. The price changes can also lead some investors to leave the markets and give rise to non-degenerate forms of participation turnover. The model is consistent with several features of financial markets over the past few decades: substantial innovation, higher participation, significant turnover in investor composition, improved risk management practices, a slight increase in interest rates, and a reduction in risk premia.
TidsskriftJournal of Financial and Quantitative Analysis
Udgave nummer3
Sider (fra-til)431-459
Antal sider29
StatusUdgivet - sep. 2004
Eksternt udgivetJa

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