The Impact of New Financial Technologies on Stock Prices
Journal of Academy of Business and Economics, Vol. 6, No. 1, 2006
14 Pages Posted: 15 Dec 2009
Date Written: November 1, 2006
This paper examines the effect of new financial technologies by examining the role of portfolio insurance in the stock market crash of 1987, and by modeling insurance as an asset enhancement technology that it is not available to all market participants. We examine the implications for the equilibrium price and asset demands for the risky asset using an overlapping generations model, and investigate the implications of misperceptions about the efficacy of the technology. Our findings have implications for both domestic and international markets. We find that a small fraction of agents using the technology can disproportionately influence risky asset price, and an infinitesimal increase in this fraction can induce a rapid increase in price. This is consistent with summary observations regarding the role of portfolio insurance in the 1987 crash. We also find the interesting result that the equilibrium asset price is disproportionately sensitive to the price forecasts of those using the technology. Finally, we identify principle weaknesses with the model, namely that parameter assumptions - risk aversion and perceived hedging efficiency - needed to attain a run-up of the asset price may be unrealistic, and that this is consistent with findings from related research.
Keywords: Financial Technology, Investor Sentiment, Asset Valuation, Portfolio Insurance
JEL Classification: D41, G12, G13
Suggested Citation: Suggested Citation