Saturday, December 25, 2010

The dark side of financial innovation (SSRN)

By Brian J. Henderson and Neil D. Pearson

Abstract: The offering prices of 64 issues of a popular retail structured equity product were, on average, almost 8% greater than estimates of the products’ fair market values obtained using option pricing methods. Under reasonable assumptions about the underlying stocks’ expected returns, the mean expected return estimate on the structured products is slightly below zero. The products do not provide tax, liquidity, or other benefits, and it is difficult to rationalize their purchase by informed rational investors. Our findings are, however, consistent with the recent hypothesis that issuing firms might shroud some aspects of innovative securities or introduce complexity to exploit uninformed investors.

Published in the Journal of Financial Economics ($$) but the working paper version is available here: papers.ssrn.com/sol3/papers.cfm?abstract_id=1342654

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