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Bundlers' dilemmas in financial markets with sampling investors

Bianchi, M; Jehiel, P; (2020) Bundlers' dilemmas in financial markets with sampling investors. Theoretical Economics , 15 (2) pp. 545-582. 10.3982/TE3726. Green open access

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Abstract

We study banks' incentive to pool assets of heterogeneous quality when investors evaluate pools by extrapolating from limited sampling. Pooling assets of heterogeneous quality induces dispersion in investors' valuations without affecting their average. Prices are determined by market clearing assuming that investors cannot borrow nor short-sell. A monopolistic bank has the incentive to create heterogeneous bundles only when investors have enough money. When the number of banks is sufficiently large, oligopolistic banks choose extremely heterogeneous bundles, even when investors have little money and even if this turns out to be collectively detrimental to the banks. If in addition banks can originate low quality assets, even at a cost, this collective inefficiency is exacerbated and pure welfare losses arise. Robustness to the presence of rational investors and to the possibility of short-selling is discussed.

Type: Article
Title: Bundlers' dilemmas in financial markets with sampling investors
Open access status: An open access version is available from UCL Discovery
DOI: 10.3982/TE3726
Publisher version: https://doi.org/10.3982/TE3726
Language: English
Additional information: Copyright © 2020 The Authors. Licensed under the Creative Commons Attribution-NonCommercial License 4.0 (https://creativecommons.org/licenses/by-nc/4.0/legalcode).
Keywords: Complex financial products, bounded rationality, disagreement, market efficiency, sampling
UCL classification: UCL
UCL > Provost and Vice Provost Offices
UCL > Provost and Vice Provost Offices > UCL SLASH
UCL > Provost and Vice Provost Offices > UCL SLASH > Faculty of S&HS
UCL > Provost and Vice Provost Offices > UCL SLASH > Faculty of S&HS > Dept of Economics
URI: https://discovery.ucl.ac.uk/id/eprint/10098362
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