This doctoral dissertation contributes to the empirical literature on financial innovation by providing new evidence on the performance, security design, and proliferation of a recent financial innovation—retail structured products. The essence of these securities is the packaging of embedded derivatives with traditional securities, such as bonds and equities. The bundled securities are complex and give investors access to non-linear and often exotic payoffs.
In the first essay, I show that banks engineer and sell to U.S. households complex securities with attractive yields but negative returns. I document this in a sample of over 20,000 yield enhancement products (YEP), which became a $20 billion market after the post-crisis fall in interest rates. YEPs carry a significant downside risk and, according to regulators, are frequently missold to inexperienced investors. The products lose money both ex ante and ex post due to their largely hidden fees: on average, YEPs charge 7% in annual fees and subsequently lose 7% relative to risk-adjusted benchmarks. The fees remain large even after the SEC mandated disclosure of product values.
In the second essay, I study the determinants of innovation in security design by analyzing $5 trillion market for retail structured products over 2002–2015. I show that demand correlates with the quoted rates of the securities which govern their potential upside returns and downside protection. At the same time, demand is inelastic with respect to the intrinsic value of the securities. Banks make securities more attractive to retail investors by enhancing their quoted rates with value-decreasing "add-ons", particularly at times when simple securities offer low upside potential.
In the third essay, "Marketing Financial Innovation," joint work with Christopher Hansman and Harrison Hong, we quantify the importance of marketing by focusing on informational spillovers from competitive entry. We apply our novel approach to the incipient market for structured retail products in Finland from 2000-2014. When a bank starts selling a product in a zip-code, early-mover banks experience higher rather than lower sales, contrary to standard competitive effects. We use quarter-by-zip fixed effects and a bank-merger based difference-in-difference strategy to identify marketing spillovers. We examine how switching costs and advertisement free-riding influence customer adoption rates.
|Tila||Julkaistu - 2019|
|OKM-julkaisutyyppi||G5 Tohtorinväitöskirja (artikkeli)|