Les Cahiers de Recherche - HEC Paris
Financial Innovation and Price Volatility
Abstract: In a three-period finite competitive exchange economy with
incomplete financial markets and retrading, we show the generic existence
of financial innovation which decreases equilibrium price volatility (as
well as innovation which increases it). The existence is obtained under
conditions of sufficient market incompleteness. The financial innnovation
may consist of an asset which is only traded at time zero, or retraded, and
with payoffs only at the terminal date. The existence is shown to be robust
in the asset payoff space.
Keywords: Incomplete markets; financial innovation; volatility; (follow links to similar papers)
JEL-Codes: C60; D52; G10; (follow links to similar papers)
30 pages, October 16, 1999
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