Financial Innovation, Market Participation and Asset Prices

47 Pages Posted: 4 Oct 2001

See all articles by Laurent E. Calvet

Laurent E. Calvet

SKEMA Business School; 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: August 2001

Abstract

This paper proposes that the introduction of non-redundant assets can endogenously modify trader participation in financial markets, which can lead to a lower market premium and a higher interest rate. We demonstrate this mechanism in a tractable exchange economy with endogenous participation. Investors receive heterogeneous random incomes determined by a finite number of macroeconomic factors. They 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 reconciles a number of features that have characterized financial markets in the past three decades: substantial financial innovation; a sharp increase in investor participation; improved risk management practices; an increase in interest rates; and a reduction in the risk premium.

Keywords: Endogenous Participation, Epstein-Zin Utility, Financial Innovation, Incomplete Markets, Multiple Risk Factors, Risk Premium, Spanning

JEL Classification: D52, E44, F36, G12

Suggested Citation

Calvet, Laurent E. and Gonzalez-Eiras, Martín and Sodini, Paolo, Financial Innovation, Market Participation and Asset Prices (August 2001). Available at SSRN: https://ssrn.com/abstract=284029 or http://dx.doi.org/10.2139/ssrn.284029

Laurent E. Calvet (Contact Author)

SKEMA Business School ( email )

5 Quai Marcel Dassault
Suresnes, 92150
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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