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Title: 

Financial Innovation, Market Participation and Asset Prices

Authors: Calvet, Laurent
Gonzalez-Eiras, Martín
Sodini, Paolo
Keywords: Endogenous participation;Epstein-Zin utility;financial innovation;incomplete markets;multiple risk factors;spanning
Issue Date: Mar-2002
Series/Report no.: FIN-02-042
Abstract: This paper theoretically investigates the pricing effects of financial innovation in an economy with endogenous participation and heterogeneous income risks. The introduction of non-redundant assets can endogenously modify the participation set, reduce the covariance between dividends and participants’ consumption and thus lead to lower risk premia. This mechanism is demonstrated in a tractable exchange economy with a finite number of macroeconomic factors. Agents can freely borrow and lend, but must pay a fixed entry cost to invest in risky assets. Security prices and the participation structure are jointly determined in equilibrium. The model is consistent with several features of financial markets over the past few decades: substantial financial innovation; a sharp increase in investor participation; improved risk management practices; a slight increase in interest rates; and a reduction in risk premia.
URI: http://hdl.handle.net/2451/26486
Appears in Collections:Finance Working Papers

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