Economics serving society

Stability of marketable payoffs with long-term assets

Jean-Marc Bonnisseau and Achis Chery

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The stability of financial markets is a crucial matter because it determines their economic efficiency and the capacity of agents to make predictions. Observation of several markets (currency, bonds, derivatives, insurance) over four decades reveals a posteriori periods of severe instability, with great price variations, as well as an explosion in the volume of exchange. This instability prevents the market from fulfilling its rôle of spreading risks among the actors. For the most part, economic theory sheds light on the instabilities linked to the price of goods for short-term assets.
In this article, Bonnisseau and Chery use simple examples to show that the price of assets themselves, introduced successively to markets in the presence of long-term assets, are a new source of instability and that this is so even when markets are complete and sufficient to cover all risks. The authors’ main contribution is to show that the stability of returns on assets, and therefore of the market, is preserved when new financial products constitute real financial innovations. In other words, new financial products cover, for future periods, risks that are not covered by pre-existing assets. Bonnisseau and Chery also find as a corollary that the market mechanism determines prices for an allocation of risk that conforms to the individual choices of economic agents. These conclusions suggest that financial regulation should monitor the diversification of assets during their introduction to the market, in order to allow the market to function as it should.
Original title of the article : “Stability of marketable payoffs with long-term assets”
Published in : Annals of Finance, June 2014
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