Interest Rates, Bounded Rationality, and Complexity: Demand and Supply of Retail Financial Products

72 Pages Posted: 30 Dec 2019 Last revised: 3 Feb 2021

See all articles by Marc Chesney

Marc Chesney

University of Zurich - Department of Banking and Finance

Felix Fattinger

WU Vienna University of Economics and Business

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 is driven by supply competition while catering to investors' bias in perceiving dependencies.

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

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

Suggested Citation

Chesney, Marc and Fattinger, Felix and Krakow, Nils Jonathan, Interest Rates, Bounded Rationality, and Complexity: Demand and Supply of Retail Financial Products (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

WU Vienna University of Economics and Business ( email )

Welthandelsplatz 1, Building D1, 3rd Floor
Vienna, 1020
Austria

Nils Jonathan Krakow (Contact Author)

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

Plattenstr 32
Zurich, 8032
Switzerland

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