Coupons, Competition, and Complexity: Security Design under Low Interest Rates
98 Pages Posted: 30 Dec 2019 Last revised: 14 Nov 2023
Date Written: October 27, 2023
We study the market for retail investment products in times of low interest rates. Combining experimental and field data, we show that decreasing interest rates drive investment demand but fail to rationalize the empirically observed increase in product complexity. In contrast, we provide evidence that banks strategically increase complexity to mitigate price competition. Because complex products bear higher down-side risk and are first-order dominated by simpler products, this strategic use of complexity results in higher uncompensated risk-taking by investors. Overall, our findings showcase how low interest rates can indirectly fuel excessive risk-taking.
Keywords: Financial innovation; reaching-for-yield; complexity; competition; risk-taking; dependency perception; overconfidence
JEL Classification: G4, D14, E44, G13, G18
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