Biais, Bruno, Rochet, Jean-Charles and Woolley, Paul (2009) The lifecycle of the financial sector and other speculative industries. Discussion paper, 632. Financial Markets Group, London School of Economics and Political Science, London, UK.
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Speculative industries exploit novel technologies subject to two risks. First, there is uncertainty about the fundamental value of the innovation: is it strong or fragile? Second, it is difficult to monitor managers, which creates moral hazard. Because of moral hazard, managers earn agency rents in equilibrium. As time goes by and profits are observed, beliefs about the industry are rationally updated. If the industry is strong, confidence builds up. Initially this spurs growth. But increasingly confident managers end up requesting very large rents, which curb the growth of the speculative sector. If rents become too high, investors may give up on incentives, and risk and failure rates rise. Furthermore, if the innovation is fragile, eventually there is a crisis, and the industry shrinks. Our model thus captures important stylized facts of the financial innovation wave which took place at the beginning of this century.
|Item Type:||Monograph (Discussion Paper)|
|Additional Information:||© 2009 The Authors|
|Uncontrolled Keywords:||Speculative industry, financial innovation, learning, moral hazard, rents, boom, crisis.|
|Library of Congress subject classification:||H Social Sciences > HF Commerce
H Social Sciences > HB Economic Theory
|Journal of Economic Literature Classification System:||G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing; Trading volume; Bond Interest Rates|
|Sets:||Research centres and groups > Financial Markets Group (FMG)
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