Financial Innovation and Asset Prices

56 Pages Posted: 6 Nov 2017

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)

Multiple version iconThere are 3 versions of this paper

Date Written: November 2017

Abstract

We study the effects of financial innovation on the dynamics of asset prices. We show that when some investors are less well informed about the new asset but rationally learn about it, many "intuitive" results are reversed: financial innovation increases the volatility of investors' portfolios along with the return volatility and risk premium for the new asset, which decline to their pre-innovation levels only slowly. Moreover, illiquidity of the new asset causes shocks to the new asset to spill over to the traditional asset, increasing their return correlation and giving rise to a liquidity premium for the new asset.

Keywords: differences in beliefs, parameter uncertainty, rational learning, recursive utility, spillover effects

JEL Classification: G11, G12

Suggested Citation

Buss, Adrian and Uppal, Raman, Financial Innovation and Asset Prices (November 2017). CEPR Discussion Paper No. DP12416. Available at SSRN: https://ssrn.com/abstract=3066028

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

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