Financial choice and financial information

Kondor, Peter ORCID: 0000-0001-9797-9291 and Koszegi, Botond (2017) Financial choice and financial information. Financial Markets Group Discussion Papers (775). Financial Markets Group, The London School of Economics and Political Science, London, UK.

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Abstract

We analyze the implications of increases in the selection of, and information about, derivative financial products in a model in which investors neglect informational differences between themselves and issuers. We assume that investors receive information that is noisy and inferior to issuers' information, and that issuers can select the set of underlying assets when designing a security. In contrast to the received wisdom that diversification is helpful, we show that when custom-designed diversification across a large number of underlying assets is possible, then expected utility approaches negative infinity. Even beyond this limiting case, any expansion in choice induced by either an increase in the maximum number of assets underlying a security, or an increase in the number of assets from which the underlying can be selected, Pareto-lowers welfare. Furthermore, under reasonable conditions an improvement in investor information Pareto-lowers welfare by giving investors the false impression that they can spot good deals. An increase in competition between issuers does not increase welfare, and even increases investors' incentive to acquire welfare reducing information. Restricting the set of underlying assets the issuer can use-a kind of standardization-raises welfare, and once this policy is adopted, increasing investor information becomes beneficial.

Item Type:	Monograph (Discussion Paper)
Official URL:	https://www.fmg.ac.uk/
Additional Information:	© 2017 The Authors
Divisions:	Finance
Subjects:	H Social Sciences > HC Economic History and Conditions H Social Sciences > HG Finance
JEL classification:	G - Financial Economics > G1 - General Financial Markets > G10 - General
Date Deposited:	02 Jun 2023 10:51
Last Modified:	01 Oct 2024 04:04
URI:	http://eprints.lse.ac.uk/id/eprint/118973

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