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Title:Financial innovation, market participation and asset prices PDF Logo
Authors:Calvet, Laurent
Gonzalez-Eiras, Martín
Sodini, Paolo
Issue Date:2001
Series/Report no.:SSE/EFI Working Paper Series in Economics and Finance 464
Abstract:This paper proposes that the introduction of non-redundant assets can endogenously modify trader participation in financial markets, which can lead to a lower market premium and a higher interest rate. We demonstrate this mechanism in a tractable exchange economy with endogenous participation. Investors receive heterogeneous random incomes determined by a finite number of macroeconomic factors. They 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 reconciles a number of features that have characterized financial markets in the past three decades: substantial financial innovation; a sharp increase in investor participation; improved risk management practices; an increase in interest rates; and a reduction in the risk premium.
Subjects:Endogenous Participation
Epstein-Zin Utility
Financial Innovation
Incomplete Markets
Multiple Risk Factors
Risk Premium
Spanning
JEL:D52
E44
G12
Document Type:Working Paper
Appears in Collections:SSE/EFI Working Paper Series in Economics and Finance, EFI - The Economic Research Institute, Stockholm School of Economics

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