What Drives Financial Complexity? A Look into the European Retail Structured Products Market

This paper investigates the relationship between complexity and competition in household finance. We theoretically show how banks with heterogeneous market shares can use complexity to capture an informational rent from unsophisticated investors. This generates a U-shaped impact of competition on complexity. Using an academically unexploited database of all European issuances of retail structured products since inception, we provide empirical evidence for this prediction. When regressing complexity on competition, we observe a non-monotonous relationship. A cross-sectional regression on distributors' market powers shows that larger competitors offer more complex products. We also find that institutions targeting mainly unsophisticated consumers offer more complex products. These findings add to our understanding of the growing gap between financial complexity and investor sophistication, and how banks can strategically exploit it to their advantage.