Financial Technology and the Inequality Gap

Abstract

In this paper, I build a theoretical model of trading under asymmetric information to study the impact of financial information technologies on capital income inequality. In the model, investors are heterogeneous in their financial sophistication and have a choice between not participating in the stock-market, investing through a passive fund, or searching for an active fund. To assess the impact of financial innovation, I reduce the cost of stock market participation and of data processing, for funds and investors, over time. I find that lower participation costs always reduce capital income inequality, but lower costs of data processing, for investors or funds, do not guarantee broad increases in household wealth. Instead, the sophisticated investors who already have relatively high levels of wealth are most likely to benefit from many of the new information technologies. The main intuition is that lower data acquisition costs, for investors or for funds, make wealthier investors acquire more valuable information. This, in turn, makes less wealthy investors more reluctant to trade in a market with a higher degree of asymmetric information. By staying out of the market, the wealth of poor investors grows less than that of rich ones.

Keywords: FinTech, Inequality, Asymmetric information, active Investing, passive investing

JEL Classification: E21, G11, G14, L1, L15