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  3. American Economic Review
  4. May 2012
  5. Financial Innovation and Asset Price Volatility

American Economic Review

ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)

Financial Innovation and Asset Price Volatility

  • Felix Kubler
  • Karl Schmedders
American Economic Review
vol. 102, no. 3, May 2012
(pp. 147–51)
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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.

Citation

Kubler, Felix, and Karl Schmedders. 2012. "Financial Innovation and Asset Price Volatility." American Economic Review, 102 (3): 147–51. DOI: 10.1257/aer.102.3.147

Additional Materials

JEL Classification

  • E44 Financial Markets and the Macroeconomy
  • G12 Asset Pricing; Trading volume; Bond Interest Rates
  • E13 General Aggregative Models: Neoclassical
  • G21 Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages