While the traditional view of financial innovation emphasizes the risk sharing role of new financial assets, belief disagreements about these assets naturally lead to speculation, which represents a powerful economic force in the opposite direction.
Theoretically, financial innovation should make markets safer by spreading risk across a wider and deeper population of investors rather than concentrating it in the hands of a relative few. A study published by MIT economist and assistant professor Alp Simesk, however, concludes that the opposite is true: financial innovation does not lower portfolio risk. Rather Simesk finds that financial innovation creates opportunities for investors to take risks, or bets, on opposing sides of deep disagreements about the value of certain investments. Simesk concludes that this actually magnifies and multiplies risk rather than reducing it. “In a world in which investors have different views, new securities won’t necessarily reduce risks,” says Simsek. “People bet on their views. And betting is inherently a risk-increasing activity.”