## Financial Innovation and Risk, the Role of Information

_IMF Working Papers, November 1, 2010_

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## Bibliographic details
- Authors: Roberto Piazza
- Published: November 1, 2010
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781455210732.001

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### 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.
- The paper studies 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 avoid 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 change in investment behavior alters business cycle properties and can reduce welfare by increasing the likelihood of "liquidation crises".

### Key Findings and Mechanisms
- Financial innovation increases diversification and lowers transaction/investment costs.
- Despite cost reductions, the relative cost of active (informed) strategies remains higher than passive strategies, leading to reduced private information acquisition.
- Lower private information collection and deterioration of public information together cause more frequent investments in excessively risky production technologies.
- The shift toward riskier investments affects business cycle dynamics and raises the probability of severe outcomes described as "liquidation crises".

### Policy-Relevant Implications
- Changes in information provision and incentives for private information collection are central to assessing the systemic risk consequences of financial innovation.
- Policies that only focus on lowering transaction costs without addressing incentives for information acquisition may inadvertently increase systemic risk and the likelihood of liquidation crises.
- Strengthening mechanisms that preserve or enhance incentives for private information acquisition, or improving the quality of public information, could mitigate the welfare costs associated with some forms of financial innovation.

### Publication and Metadata
- Author: Roberto Piazza
- Date: November 1, 2010
- Series: Working Paper No. 2010/266
- Issue: 266
- Volume: 2010
- Pages: 31
- DOI: https://doi.org/10.5089/9781455210732.001
- Stock No: WPIEA2010266
- ISBN: 9781455210732
- ISSN: 1018-5941
- Preview citation format (Chicago): Roberto Piazza. "Financial Innovation and Risk, the Role of Information", IMF Working Papers 2010, 266 (2010), accessed 9/17/2026, https://doi.org/10.5089/9781455210732.001
- Subjects: Business cycles, Financial sector development, Moral hazard, Systemic risk, Technology
- Keywords: appendix E, business cycle, mover accent, WP

*IMF Working Papers — Financial Innovation and Risk, the Role of Information, Roberto Piazza, Working Paper No. 2010/266 (November 1, 2010).*

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/31/financial-innovation-and-risk-the-role-of-information-24372_