Boom and bust patterns in the adoption of financial innovations

We develop a dynamic model of the adoption of financial innovations.Each period, firms decide whether or not to adopt an innovationof uncertain value, and the profitability of each period's adoptionsreveals information about the innovations's value. We show thatcharacteristics of financial innovation waves cited by criticsas evidence of irrational excess are, in fact, consistent withfully rational behavior. We also show that social welfare isenhanced when more firms adopt innovations of questionable valueand that financial intermediaries have an incentive to encouragesuch adoption.