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https://hdl.handle.net/10419/125560

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Cursed financial innovation

[working paper]

Kondor, Péter
Köszegi, Botond

Corporate Editor
Wissenschaftszentrum Berlin für Sozialforschung gGmbH

Abstract

We analyze the welfare properties of derivative securities that profit-maximizing issuers offer to investors who have inferior information and neglect the information content of the offer. To capture the markets for structured securities and exotic exchange-traded funds, we assume that issuers can c... view more

We analyze the welfare properties of derivative securities that profit-maximizing issuers offer to investors who have inferior information and neglect the information content of the offer. To capture the markets for structured securities and exotic exchange-traded funds, we assume that issuers can choose both the underlying asset and the form of the security. An issuer's optimal security induces investors to bet on unlikely market movements, creating both excess risk taking and undersaving. Giving more information to the issuer leads it to choose an underlying asset on which its information is more extreme, exacerbating both effects and hence lowering social welfare. Furthermore, providing inferior and noisy additional information to investors also lowers welfare because the security is then written on an underlying asset about which the information is misleading. If the issuer can base its security on a combination of underlying assets, it optimally creates a "custom-designed" index to maximize its informational advantage and minimize risk, minimizing investor and social welfare. Restricting the set of underlying assets -a kind of standardization- increases welfare by preventing the issuer from systematically selling a security with extreme or misleading information. Once this policy is adopted, increasing investor information becomes beneficial. (author's abstract)... view less

Keywords
securities; capital assets; investment; risk behavior; information; security

Classification
Financial Planning, Accountancy

Document language
English

Publication Year
2015

City
Berlin

Page/Pages
42 p.

Series
Discussion Papers / Wissenschaftszentrum Berlin für Sozialforschung, Forschungsschwerpunkt Markt und Entscheidung, Abteilung Ökonomik des Wandels, SP II 2015-306

Handle
https://hdl.handle.net/10419/125560

Status
Published Version; reviewed

Licence
Deposit Licence - No Redistribution, No Modifications


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© 2007 - 2025 Social Science Open Access Repository (SSOAR).
Based on DSpace, Copyright (c) 2002-2022, DuraSpace. All rights reserved.