The Implications of Financial Innovation for Capital Markets and Household Welfare

43 Pages Posted: 9 Aug 2017 Last revised: 22 Aug 2018

See all articles by Adrian Buss

Adrian Buss

INSEAD - Finance; Centre for Economic Policy Research (CEPR)

Raman Uppal

EDHEC Business School; Centre for Economic Policy Research (CEPR)

Grigory Vilkov

Frankfurt School of Finance & Management

Multiple version iconThere are 3 versions of this paper

Date Written: August 21, 2018

Abstract

Our objective is to understand how financial innovation affects investors' optimal asset-allocation decisions and the economic mechanisms through which these decisions influence financial markets, welfare, and wealth inequality. We show that when some investors, such as households, are less confident than other investors about the dynamics of the new asset made available by financial innovation, but learn over time, many ''intuitive'' results are reversed: financial innovation increases the return volatility and risk premium of the new asset along with volatilities of investors' portfolios. Despite the increase in volatilities, financial innovation improves the welfare of all investors but worsens wealth inequality because experienced investors benefit more from it.

Keywords: household finance, household portfolio choice, wealth inequality, differences in beliefs, parameter uncertainty, Bayesian learning, recursive utility.

JEL Classification: G11, G12, D53

Suggested Citation

Buss, Adrian and Uppal, Raman and Vilkov, Grigory, The Implications of Financial Innovation for Capital Markets and Household Welfare (August 21, 2018). INSEAD Working Paper No. 2017/52/FIN. Available at SSRN: https://ssrn.com/abstract=3015208 or http://dx.doi.org/10.2139/ssrn.3015208

Adrian Buss (Contact Author)

INSEAD - Finance ( email )

Boulevard de Constance
Fontainebleau Cedex, 77305
France
+33 160 72 44 84 (Phone)
+33 160 72 40 45 (Fax)

HOME PAGE: http://sites.google.com/view/abuss

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Raman Uppal

EDHEC Business School ( email )

58 rue du Port
Lille, 59046
France

Centre for Economic Policy Research (CEPR)

90-98 Goswell Road
London, EC1V 7RR
United Kingdom

Grigory Vilkov

Frankfurt School of Finance & Management ( email )

Adickesallee 32-34
Frankfurt am Main, 60322
Germany

HOME PAGE: http://www.vilkov.net

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