Engineering Lemons

Recent complex financial products sold to households contradict the basic premise of canonical innovation theories: financial innovation benefits its adopters. In my 2006–2015 sample of over 28,000 yield enhancement products (YEP) the securities offer attractive yields but negative returns. The products lose money both ex ante and ex post due to their embedded fees: on average, YEPs charge 6–7% in annual fees and subsequently lose 6–7% relative to risk-adjusted benchmarks. Simple and cheap combinations of listed options often first-order dominate YEPs. Competition, disclosure, or learning do not eliminate this inferior financial innovation over my sample period.

Keywords: Household finance; financial innovation; hidden costs; complexity; structured products

JEL Classification: G4, G13, G14, G18

Suggested Citation: Suggested Citation

Vokata, Petra, Engineering Lemons (June 27, 2018). Journal of Financial Economics (JFE), Forthcoming, Fisher College of Business Working Paper No. 2020-03-021, Charles A. Dice Center Working Paper No. 2020-21, 9th Miami Behavioral Finance Conference 2018, Available at SSRN: https://ssrn.com/abstract=3223427 or http://dx.doi.org/10.2139/ssrn.3223427