Speculators who prey on hedgers can stifle financial innovation in the sense that new markets can fail. In this paper I analyze whether a profit maximizing exchange nonetheless chooses to open markets for speculative securities and if so, how to circumvent the problem of market failure. I find that the optimal financial innovation takes two forms. The first is a market structure consisting of hedge instruments, traded in low volume at stable asset prices. The second is a market structure consisting of speculative instruments, traded in greater volume at volatile asset prices. These strategies are derived within the same framework where the cost and the quality of the speculators' information set and the hedgers risk aversion ultimately determine which is the optimal one.

The objective of this paper is to investigate whether financial innovation of credit derivatives makes banks more exposed to credit risk. Although credit derivatives are important for hedging and securitizing credit risk – and thereby likely to enhance the sharing of such risk – some commentators have raised concerns that they may destabilize the banking sector. This paper investigates this issue in a simple model driven by costs of financial distress. The analysis identifies two effects of credit derivatives innovation – they enhance risk sharing as suggested by the hedging argument – but they also make further acquisition of risk more attractive. The latter effect, if dominant, can therefore destabilize the banking sector. The critical factor is, perhaps surprisingly, the competitive nature of the existing underlying credit markets. As these markets become more elastic the threat of destabilization increases. The paper discusses issues related to bank regulation within the context of the model.

This paper investigates how conservative managers make corporate decisions. Motivated by psychology research, we use handwritten signatures (i.e., emotionally restraint disclosure styles) as a proxy for CEO conservatism. We find that firms with conservative CEOs engage more with safer investments (capital expenditures), engage less with risky policies (Research & Development expenses and debt financing), hold more cash, are less likely to pay cash dividends, and more likely to use stock repurchase schemes. We use the same proxy for CFO conservatism. We find that CFO conservatism is a better determinant than CEO conservatism for cash holding and financing policies, but the reverse is true for investment policies. Conservative CFOs prefer long-term debt to short-term debt.