Boom and Bust Patterns in the Adoption of Financial Innovations

We develop a dynamic model of the adoption of financial innovations. Each period, firms decide whether or not to adopt an innovation of uncertain value, and the profitability of each period's adoptions reveals information about the innovation's value. We show that characteristics of financ...

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Bibliographic Details
Published in:The Review of financial studies 1997, Vol.10 (4), p.939-967
Main Authors: Persons, John C., Warther, Vincent A.
Format: Article
Language:English
Subjects:
Business innovation
Business structures
Capital market
Collateralized mortgage obligations
Economic busts
Efficient markets
Enterprises
Financial innovation
Financial management
Information economics
Innovation
Innovation adoption
Innovations
LBO
Learning rate
Leveraged buyouts
Observational learning
Outcomes of education
Profitability
Profits
Rationality
Social welfare
Technological innovation
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Summary:We develop a dynamic model of the adoption of financial innovations. Each period, firms decide whether or not to adopt an innovation of uncertain value, and the profitability of each period's adoptions reveals information about the innovation's value. We show that characteristics of financial innovation waves cited by critics as evidence of irrational excess are, in fact, consistent with fully rational behavior. We also show that social welfare is enhanced when more firms adopt innovations of questionable value and that financial intermediaries have an incentive to encourage such adoption.
ISSN:0893-9454
1465-7368
DOI:10.1093/rfs/10.4.939