Abstract
Financial innovation introduces the possibility of exchange on wider time-events sets. In this way, market incompleteness should be reduced with an overall advantage. The existence of this advantage also depends on other elements, like the degree of market competition, the level of information, and the presence of inefficiencies generated by moral hazard. One kind of behavior which has been widely common among banks consists in the reduction of risk taking in relation to credit activity. Credit risk tends to be covered through the packaging of credits into securities. This situation means that since the bank is not shouldering the risk, it does not invest in the acquisition of knowledge regarding the borrower, but only regarding his/her generic characteristics which are reflected in the evaluation of the assets in which the credits are packaged. Moreover, financial innovation was developed, in particular by investment banks, with non-standardized products, exchanged over-the-counter, and substantially lacking secondary markets. The greatest problems derive from the low liquidity of these products and from the uncertainty over their returns. This is why it would be good to stimulate the introduction of standardized products, whose risks are easy to determine, to be exchanged on organized markets, instead of complex products, which are substantially illiquid and exchanged over-the-counter.
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Notes
About financial innovation see, for instance, Tufano (2003).
Jenkinson (2008) points out the role of uncertainty (indicated as Knightian uncertainty) in the financial market. The incompleteness of financial markets in presence of uncertainty aversion is presented in general terms by Mukerji and Tallon (2001), the reduction of trading volumes by Montesano (2008).
For instance, Roubini (2008).
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Montesano, A. Risk allocation and uncertainty: some unpleasant outcomes of financial innovation. Int Rev Econ 56, 243–250 (2009). https://doi.org/10.1007/s12232-009-0074-9
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DOI: https://doi.org/10.1007/s12232-009-0074-9