Discussion Paper Details

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Title: The Implications of Financial Innovation for Capital Markets and Household Welfare

Author(s): Adrian Buss, Raman Uppal and Grigory Vilkov

Publication Date: August 2018

Keyword(s): Bayesian learning, differences in beliefs, household finance, household portfolio choice, parameter uncertainty, recursive utility and Wealth Inequality

Programme Area(s): Financial Economics

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.

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Bibliographic Reference

Buss, A, Uppal, R and Vilkov, G. 2018. 'The Implications of Financial Innovation for Capital Markets and Household Welfare'. London, Centre for Economic Policy Research.