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Financial innovation and asset price volatility


Schmedders, Karl; Kübler, Felix (2012). Financial innovation and asset price volatility. American Economic Review, 102(3):147-151.

Abstract

We compare asset prices in an overlapping generations model for incomplete and complete markets. Individuals within a generational cohort have heterogeneous beliefs about future states of the economy and thus would like to make bets against each other. In the incomplete-markets economy, agents cannot make such bets. Asset price volatility is very small. The situation changes dramatically when markets are completed through financial innovations as the set of available securities now allows agents with different beliefs to place bets against each other. Wealth shifts across agents and generations. Such changes in the wealth distribution lead to substantial asset price volatility.

Abstract

We compare asset prices in an overlapping generations model for incomplete and complete markets. Individuals within a generational cohort have heterogeneous beliefs about future states of the economy and thus would like to make bets against each other. In the incomplete-markets economy, agents cannot make such bets. Asset price volatility is very small. The situation changes dramatically when markets are completed through financial innovations as the set of available securities now allows agents with different beliefs to place bets against each other. Wealth shifts across agents and generations. Such changes in the wealth distribution lead to substantial asset price volatility.

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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Business Administration
Dewey Decimal Classification:330 Economics
Language:English
Date:1 January 2012
Deposited On:04 Jun 2012 06:58
Last Modified:16 Feb 2018 23:30
Publisher:American Economic Association
ISSN:0002-8282
OA Status:Green
Publisher DOI:https://doi.org/10.1257/aer.102.3.147
Other Identification Number:merlin-id:6994

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