Financial Innovation and Risk: The Role of Information

44 Pages Posted: 30 Oct 2010

Date Written: June 30, 2010

Abstract

Financial innovation has increased opportunities for diversification and lowered investment costs, but has not reduced the relative cost of active (informed) investment strategies compared with passive (less informed) strategies. What are the consequences? I have studied an economy with linear production technologies, some more risky than others. Investors can use low quality public information or collect high quality, but costly, private information. Information helps in avoiding excessively risky investments. Financial innovation lowers the incentives for private information collection and causes a deterioration in public information: the economy more often invests in excessively risky technologies. This changes the properties of the business cycle and can reduce welfare by increasing the likelihood of “liquidation crises".

Keywords: Financial innovation, information collection, great moderation, liquidation crisis

JEL Classification: G14, G33, G01, E32

Suggested Citation

Piazza, Roberto, Financial Innovation and Risk: The Role of Information (June 30, 2010). Bank of Italy Temi di Discussione (Working Paper) No. 759, Available at SSRN: https://ssrn.com/abstract=1699225 or http://dx.doi.org/10.2139/ssrn.1699225

Roberto Piazza (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

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