Low Interest Rates, Bounded Rationality, and Product Complexity: Demand and Supply Effects for Retail Financial Markets

72 Pages Posted: 30 Dec 2019 Last revised: 15 Jun 2020

See all articles by Marc Chesney

Marc Chesney

University of Zurich - Department of Banking and Finance

Felix Fattinger

University of Melbourne - Department of Finance

Nils Jonathan Krakow

University of Zurich - Department of Banking and Finance

Date Written: December 6, 2019

Abstract

This paper studies the market for yield enhancement products (YEPs). We document a substantial increase in volumes, followed by a striking rise in product complexity. This pattern is paralleled by sharply falling and plateauing interest rates. We experimentally show that, while decreasing interest rates increase individuals' willingness to bear risk, it is their risk misestimation that creates demand for more complex products. By analyzing 4,460 issued YEPs, we find that (i) issuer margins are increasing in product complexity, (ii) average investment returns are negative, (iii) product complexity appears driven by supply competition and caters to investors' bias in perceiving dependencies.

Keywords: Financial innovation; complexity; retail finance; reaching for yield; dependency perception

JEL Classification: G4, D14, E44, G13, G18

Suggested Citation

Chesney, Marc and Fattinger, Felix and Krakow, Nils Jonathan, Low Interest Rates, Bounded Rationality, and Product Complexity: Demand and Supply Effects for Retail Financial Markets (December 6, 2019). Available at SSRN: https://ssrn.com/abstract=3499660 or http://dx.doi.org/10.2139/ssrn.3499660

Marc Chesney

University of Zurich - Department of Banking and Finance ( email )

Rämistrasse 71
Zürich, CH-8006
Switzerland

HOME PAGE: http://https://www.bf.uzh.ch/en/persons/chesney-marc

Felix Fattinger

University of Melbourne - Department of Finance ( email )

Faculty of Economics and Commerce
Parkville, Victoria 3010
Australia

Nils Jonathan Krakow (Contact Author)

University of Zurich - Department of Banking and Finance ( email )

Plattenstr 32
Zurich, 8032
Switzerland

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