Financial Innovation, Collateral and Investment
We show that ﬁnancial innovations that change the collateral capacity of assets in the economy can aﬀect investment even in the absence of any shift in utilities, productivity, or asset payoﬀs. First we show that the ability to leverage an asset by selling non-contingent promises can generate over-investment compared to the Arrow-Debreu level. Second, we show that the introduction of naked CDS can generate under-investment with respect to the Arrow-Debreu level. Finally, we show that the introduction of naked CDS can robustly destroy competitive equilibrium.
Fostel, Ana and Geanakoplos, John, "Financial Innovation, Collateral and Investment" (2013). Cowles Foundation Discussion Papers. 2286.