[FoRK] Computational Complexity and Information Asymmetry in Financial Products (Working paper)

Jeff Bone jbone at place.org
Thu Oct 15 17:40:46 PDT 2009


Excellent paper.


     http://www.cs.princeton.edu/~rongge/derivative.pdf


Abstract


Traditional economics argues that financial derivatives, like CDOs and  
CDSs, ameliorate the
negative costs imposed by asymmetric information. This is because  
securitization via derivatives
allows the informed party to find buyers for less information- 
sensitive part of the cash flow
stream of an asset (e.g., a mortgage) and retain the remainder. In  
this paper we show that this
viewpoint may need to be revised once computational complexity is  
brought into the picture.
Using methods from theoretical computer science this paper shows that  
derivatives can actually
amplify the costs of asymmetric information instead of reducing them.  
Note that computational
complexity is only a small departure from full rationality since even  
highly sophisticated investors
are boundedly rational due to a lack of requisite computational  
resources.


--

jb




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