Financial Innovation and Risk, the Role of Information

Author/Editor:

Roberto Piazza

Publication Date:

November 1, 2010

Electronic Access:

Free Download. Use the free Adobe Acrobat Reader to view this PDF file

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

Financial innovation has increased diversification opportunities and lowered investment costs, but has not reduced the relative cost of active (informed) investment strategies relative to passive (less informed) strategies. What are the consequences? I study an economy with linear production technologies, some more risky than others. Investors can use low quality public information or collect high quality, but costly, private information. Information helps avoiding excessively risky investments. Financial innovation lowers the incentives for private information collection and deteriorates public information: the economy invests more often in excessively risky technologies. This changes the business cycle properties and can reduce welfare by increasing the likelihood of "liquidation crises"

Series:

Working Paper No. 2010/266

Subject:

Business cycles Financial sector development Moral hazard Systemic risk Technology

English

Publication Date:

November 1, 2010

ISBN/ISSN:

9781455210732/1018-5941

Stock No:

WPIEA2010266

Pages:

31

Please address any questions about this title to publications@imf.org