The Hidden Soul of Financial Innovation: An Agent-Based Modelling of Home Mortgage Securitization and the Finance-Growth Nexus Economic Modelling

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Abstract

This paper investigates the interaction between financial innovation and securitization. To this end, it introduces the rate of financial innovation (RoFIN) as an endogenous variable in an Agent-Based Model (ABM) set up and studies its interaction with the non-fixed fraction of securitized mortgage loans. RoFIN is able to capture financial agents’ business decisions on using financial innovation tools, processes and services, such as the home mortgage securitization process. In the aftermath of the 2007-2009 financial and economic crisis it has been argued that financial innovation and securitization have increased macro/finance systemic instability via, for example, non-linear two-way spillovers between the financial system and the macroeconomy. The ABM model proposed enables the capture of these dynamics. High values of RoFIN (i.e. exceeding the threshold of 50%) make financial innovation become harmful for the economic system, leading to a switch from a virtuous to an unvirtuous business cycle. When RoFIN reaches 90%, the numerical simulations come close to the macro/finance dynamics observed before and during the financial crisis. Given its potential role in triggering financial and economic instability, RoFIN is of interest for financial regulation and supervision. How this endogenous variable may be influenced by means of operational variables under the control of policymakers remains a subject for future research.
Original languageEnglish
Pages (from-to)51-73
Number of pages23
JournalEconomic Modelling
Volume68
Early online date3 Jun 2017
DOIs
Publication statusPublished - Jan 2018
Externally publishedYes

Bibliographical note

NOTICE: this is the author’s version of a work that was accepted for publication in Economic Modelling. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in Economic Modelling, 68, (2018) DOI: 10.1016/j.econmod.2017.04.019

© 2018, Elsevier. Licensed under the Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International http://creativecommons.org/licenses/by-nc-nd/4.0/

Keywords

  • Finance
  • Growth
  • securitization
  • Financial Innovation
  • Financial Crisis
  • Agent-based simulation

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