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Rev Fin 1997; 10:939-967
© 1997 the Society for Financial Studies

Article

Boom and bust patterns in the adoption of financial innovations

JC Persons and VA Wartherz
Ohio State University, OH, USA
z Corresponding author at: University of Michigan Business School, 701 Tappan, Ann Arbor, MI 48109-1234, USA. E-mail: vwarther@umich.edu

Abstract

We develop a dynamic model of the adoption of financial innovations. Each period, firms decide whether or not to adopt an innovation of uncertain value, and the profitability of each period's adoptions reveals information about the innovations's value. We show that characteristics of financial innovation waves cited by critics as evidence of irrational excess are, in fact, consistent with fully rational behavior. We also show that social welfare is enhanced when more firms adopt innovations of questionable value and that financial intermediaries have an incentive to encourage such adoption.


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