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Discussion Paper Details

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Title: Financial Innovation and Asset Prices

Author(s): Adrian Buss and Raman Uppal

Publication Date: November 2017

Keyword(s): differences in beliefs, parameter uncertainty, rational learning, recursive utility and spillover effects

Programme Area(s): Financial Economics

Abstract: We study the effects of financial innovation on the dynamics of asset prices. We show that when some investors are less well informed about the new asset but rationally learn about it, many "intuitive'' results are reversed: financial innovation increases the volatility of investors' portfolios along with the return volatility and risk premium for the new asset, which decline to their pre-innovation levels only slowly. Moreover, illiquidity of the new asset causes shocks to the new asset to spill over to the traditional asset, increasing their return correlation and giving rise to a liquidity premium for the new asset.

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Bibliographic Reference

Buss, A and Uppal, R. 2017. 'Financial Innovation and Asset Prices'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=12416