COWLES FOUNDATION FOR RESEARCH IN
ECONOMICS Box 208281
COWLES FOUNDATION DISCUSSION PAPER NO. 1903 Financial Innovation, Collateral and Investment Ana Fostel and John Geanakoplos July 2013 We show that financial innovations that change the collateral capacity
of assets in the economy can affect investment even in the absence of any shift in
utilities, productivity, or asset payoffs. First we show that the ability to leverage an
asset by selling non-contingent promises can generate over-investment compared to the
Arrow-Debreu level. Second, we show that the introduction of naked CDS can generate
under-investment with respect to the Arrow-Debreu level. Finally, we show that the
introduction of naked CDS can robustly destroy competitive equilibrium. |
