Working Paper: CEPR ID: DP13137
Authors: Adrian Buss; Raman Uppal; Grigory Vilkov
Abstract: Our objective is to understand how financial innovation affects investors' optimal asset-allocation decisions and the economic mechanisms through which these decisions influence financial markets, welfare, and wealth inequality. We show that when some investors, such as households, are less confident than other investors about the dynamics of the new asset made available by financial innovation, but learn over time, many ''intuitive'' results are reversed: financial innovation increases the return volatility and risk premium of the new asset along with volatilities of investors' portfolios. Despite the increase in volatilities, financial innovation improves the welfare of all investors but worsens wealth inequality because experienced investors benefit more from it.
Keywords: household finance; household portfolio choice; wealth inequality; differences in beliefs; parameter uncertainty; bayesian learning; recursive utility
JEL Codes: G11; G12; D53
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| financial innovation (O16) | return volatility (G17) |
| financial innovation (O16) | risk premium (G19) |
| financial innovation (O16) | portfolio volatilities (G17) |
| inexperienced investors learning (G11) | return volatility (G17) |
| financial innovation (O16) | welfare of all investors (G23) |
| financial innovation (O16) | wealth inequality (D31) |
| inexperienced investors learning (G11) | wealth share (D33) |