Innovations, rents and risk

Biais, Bruno, Rochet, Jean-Charles and Woolley, Paul (2010) Innovations, rents and risk. Financial Markets Group Discussion Papers (659). Financial Markets Group, The London School of Economics and Political Science, London, UK.

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Abstract

We offer a rational expectations model of the dynamics of innovative industries. The fundamental value of innovations is uncertain and one must learn whether they are solid or fragile. Also, when the industry is new, it is difficult to monitor managers and make sure they exert the effort necessary to reduce default risk. This gives rise to moral hazard. In this context, initial successes spur optimism and growth. But increasingly confident managers end up requesting large rents. If these become too high, investors give up on incentives, and default risk rises. Thus, moral hazard gives rise to endogenous crises and fat tails in the distribution of aggregate default risk. We calibrate our model to fit the stylized facts of the MBS industry's boom and bust cycle.

Item Type:	Monograph (Discussion Paper)
Official URL:	https://www.fmg.ac.uk/
Additional Information:	© 2010 The Authors
Divisions:	LSE
Subjects:	H Social Sciences > HC Economic History and Conditions H Social Sciences > HG Finance
JEL classification:	O - Economic Development, Technological Change, and Growth > O3 - Technological Change; Research and Development > O30 - General
Date Deposited:	29 Jun 2023 11:09
Last Modified:	11 Dec 2024 19:47
URI:	http://eprints.lse.ac.uk/id/eprint/119082

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