Macro Seminars Amsterdam

Plamen Nenov (BI Norwegian Business School, Norway)
Friday, 22 April 2016

Financial innovations in recent decades have vastly expanded investors’portfolio choice. We theoretically analyze the e¤ect of greater choice on investors’savings and asset returns in a model in which investors have possibly heterogeneous beliefs about asset payo¤s. Under mild assumptions, we establish a choice channel by which greater portfolio choice increases investors’ (perceived) return from saving, and induces them to save more. The saving rate increases relatively more for wealthier and less risk averse investors. The general equilibrium e¤ects of the choice channel on asset returns depends on the type of …nancial innovation. We show that portfolio customization, which we capture with improved ability to trade risky assets other than the market portfolio, reduces the expected return on every asset. This result is consistent with the decline in the risk-free interest rate since the early 1980s, and is in contrast with the “precautionary savings”literature that would make the opposite prediction. In contrast, market participation (improved ability to trade the market portfolio) reduces the risk premia but typically increases the risk-free rate. We also analyze securitization, which we capture with a relaxation of constraints to issue risk-free debt in an environment in which some investors have a high demand for safe assets. Joint with Felipe S. Iachany and Alp Simsek.