Finance in a Time of Disruptive Growth

We build a model in which the arrival of new technologies displaces demand for old technologies. This disruption causes redistribution due to lack of risk sharing both within and across investor cohorts. We model the financial industry as a costly device to improve risk sharing, and determine its size in equilibrium. We further study wealth dynamics, equilibrium prices, and flows into various asset classes. We show that an increase in disruptive activity renders existing firms’ publicly traded equities riskier and makes “alternative asset classes” as diverse as fixed income, real estate, and private equity become more attractive. The result is a decline in the real interest rate, an expansion of the financial industry, and increased flows towards alternative asset classes. Interestingly, alternative asset classes offer higher expected rates of return than conventional equities despite the diversification benefits afforded by the former.