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An Evolutionary Approach to Financial Innovation

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  • Marc Oliver Bettzüge
  • Thorsten Hens

Abstract

The purpose of this paper is to explain why some markets for financial products take off while others vanish as soon as they have emerged. To this end, we model an infinite sequence of CAPM-economies in which financial products can be used for insurance purposes. Agents' participation in these financial products, however, is restricted. Consecutive stage economies are linked by a mapping ("transition function") which determines the next period's participation structure from the preceding period's participation. The transition function generates a dynamic process of market participation which is driven by the percentage of informed traders and the rate at which a new asset is adopted. We then analyse the evolutionary stability of stationary equilibria. In accordance with the empirical literature on financial innovation, it is obtained that the success of a financial innovation, a mutation, depends on a sufficiently high trading volume, marketing, and new and differentiated hedging opportunities. In particular, a set of complete markets forming a stationary equilibrium is robust with respect to any further financial innovation while this is not necessarily true for a set of incomplete markets.

Suggested Citation

  • Marc Oliver Bettzüge & Thorsten Hens, 2001. "An Evolutionary Approach to Financial Innovation," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 68(3), pages 493-522.
    • Handle: RePEc:oup:restud:v:68:y:2001:i:3:p:493-522.
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    File URL: http://hdl.handle.net/10.1111/1467-937X.00178
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    Citations

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    Cited by:

    1. Tamer Khraisha & Keren Arthur, 2018. "Can we have a general theory of financial innovation processes? A conceptual review," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 4(1), pages 1-27, December.
    2. Levy, Moshe, 2005. "Is risk-aversion hereditary?," Journal of Mathematical Economics, Elsevier, vol. 41(1-2), pages 157-168, February.
    3. Laborda Herrero, Juan & Laborda Herrero, Ricardo & Inurrieta Beruete, Alejandro, 2015. "El sistema de pensiones de reparto frente a los sistemas financiados: Una crítica a la teoría neoclásica/The Pay-As-You-Go Pension System against the Funded Schemes: A Criticism of the Neoclassical Th," Estudios de Economia Aplicada, Estudios de Economia Aplicada, vol. 33, pages 759-782, Septiembr.
    4. Anke Gerber & Marc Bettzüge, 2007. "Evolutionary choice of markets," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 30(3), pages 453-472, March.
    5. Hara, Chiaki, 2011. "Pareto improvement and agenda control of sequential financial innovations," Journal of Mathematical Economics, Elsevier, vol. 47(3), pages 336-345.
    6. Schinckus, Christophe, 2017. "Financial innovation as a potential force for a positive social change: The challenging future of social impact bonds," Research in International Business and Finance, Elsevier, vol. 39(PB), pages 727-736.
    7. Christophe Schinckus, 2007. "Sur la pluridisciplinarité contemporaine en finance," Revue d'Économie Financière, Programme National Persée, vol. 87(1), pages 247-260.
    8. Schinckus, Christophe, 2008. "The financial simulacrum: The consequences of the symbolization and the computerization of the financial market," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 37(3), pages 1076-1089, June.

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