The choice channel of financial innovation

Abstract

Financial innovation in recent decades has expanded portfolio choice. We investigate how greater choice a¤ects investors.savings and asset returns. We establish a choice channel by which greater portfolio choice increases investors.(nonprecautionary) savings. by enabling them to earn the aggregate risk premium or take speculative positions. In equilibrium, portfolio customization (access to risky assets other than the market portfolio) reduces the risk-free rate, whereas participation reduces the risk premium but typically increases the risk-free rate. Empirically, we show that stock market participants in the U.S. save more than nonparticipants, and have increasingly dispersed portfolio returns, consistent with the choice channel.