BOOM AND BUST PATTERNS IN THE ADOPTION OF FINANCIAL INNOVATIONS

We develop a dynamic model of the adoption of financial innovations. E ach period, firms decide whether or not to adopt an innovation of unce rtain value, and the profitability of each period's adoptions reveals information about the innovation's value. we show that characteristics of financial innovation waves cited by critics as evidence of irratio nal excess are, in fact, consistent with fully rational behavior We al so show that social welfare is enhanced when more firms adopt innovati ons of questionable value and that financial intermediaries have an in centive to encourage such adoption.