Financial Innovation, Market Participation and Asset Prices

50 Pages Posted: 12 Nov 2008

See all articles by Laurent E. Calvet

Laurent E. Calvet

EDHEC Business School - Department of Economics & Finance; CEPR

Martín Gonzalez-Eiras

University of Copenhagen

Paolo Sodini

Stockholm School of Economics - Department of Finance; Swedish House of Finance

Multiple version iconThere are 4 versions of this paper

Date Written: March 2002

Abstract

This paper theoretically investigates the pricing effects of financial innovation in an economy with endogenous participation and heterogeneous income risks. The introduction of non-redundant assets can endogenously modify the participation set, reduce the covariance between dividends and participants consumption and thus lead to lower risk premia. This mechanism is demonstrated in a tractable exchange economy with a finite number of macroeconomic factors. Agents 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 is consistent with several features of financial markets over the past few decades: substantial financial innovation; a sharp increase in investor participation; improved risk management practices; a slight increase in interest rates; and a reduction in risk premia.

Keywords: Endogenous participation, Epstein-Zin utility, financial innovation, incomplete markets, multiple risk factors, spanning

Suggested Citation

Calvet, Laurent E. and Gonzalez-Eiras, Martín and Sodini, Paolo, Financial Innovation, Market Participation and Asset Prices (March 2002). NYU Working Paper No. S-MF-02-03, Available at SSRN: https://ssrn.com/abstract=1300226

Laurent E. Calvet (Contact Author)

EDHEC Business School - Department of Economics & Finance ( email )

France

CEPR ( email )

33 Great Sutton Street
London, EC1V 0DX
United Kingdom

Martín Gonzalez-Eiras

University of Copenhagen ( email )

Nørregade 10
Copenhagen, København DK-1165
Denmark

Paolo Sodini

Stockholm School of Economics - Department of Finance ( email )

Sveavagen 65, Box 6501
SE-113 83 Stockholm
Sweden
46 8 7369165 (Phone)
46 8 312327 (Fax)

HOME PAGE: http://www.hhs.se/secfi/People/Faculty/Finpso/finp

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

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