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Financial innovation

In: Handbook of the Economics of Finance

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  • Tufano, Peter
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    Abstract

    Although financial innovation has been an important part of the financial landscape throughout modern economic history, it has received relatively little attention in academia. This essay surveys the existing literature on financial innovation from the disciplines of financial economics, history, law, and industrial organization. I begin by defining financial innovation and discussing problems with creating taxonomies of financial innovations. I then discuss the explanations given for the extensive amount of financial innovation we observe both today and in history, which include: (a) completing inherently incomplete markets; (b) addressing persistent agency concerns and information asymmetries; (c) minimizing transaction, search or marketing costs; (d) responding to tax and regulatory forces; (e) responding to changes in economic conditions, in particular new or newly perceived risks; and (f) capitalizing on technological developments. I review work that studies the identity of innovators, the process of diffusion of innovation, and private benefits of innovation. I illustrate these general trends with a description of a sequence of innovations that show that repeated experimentation and failure characterize the evolutionary process. As difficult as it may be to measure the private benefits to innovators, it has proven even more problematic to conclusively model or measure the social welfare benefits of financial innovation, although one can point to specific innovations that appear to enhance welfare.

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    This chapter was published in:

  • G.M. Constantinides & M. Harris & R. M. Stulz (ed.), 2003. "Handbook of the Economics of Finance," Handbook of the Economics of Finance, Elsevier, edition 1, volume 1, number 1, June.
    This item is provided by Elsevier in its series Handbook of the Economics of Finance with number 1-06.

    Handle: RePEc:eee:finchp:1-06

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    Web page: http://www.elsevier.com/wps/find/bookseriesdescription.cws_home/BS_HE/description

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    Cited by:
    1. Awrey, Dan, 2013. "Toward a supply-side theory of financial innovation," Journal of Comparative Economics, Elsevier, vol. 41(2), pages 401-419.
    2. Bruno Rossignoli & Francesca Arnaboldi, 2009. "Financial innovation: theoretical issues and empirical evidence in Italy and in the UK," International Review of Economics, Springer, vol. 56(3), pages 275-301, September.
    3. Agur, Itai & Demertzis, Maria, 2013. "“Leaning against the wind” and the timing of monetary policy," Journal of International Money and Finance, Elsevier, vol. 35(C), pages 179-194.
    4. W. Scott Frame & Lawrence J. White, 2009. "Technological Change, Financial Innovation, and Diffusion in Banking," Working Papers 09-03, New York University, Leonard N. Stern School of Business, Department of Economics.
    5. Gill, Andrej & Juranek, Steffen & Lizarazo, Christian & Visnjic, Nikolai & Walz, Uwe, 2012. "Anreize, systemische Risiken und Intransparenz: Lehren aus der Finanz- und Staatsschuldenkrise," CFS Working Paper Series 2013/01, Center for Financial Studies (CFS).
    6. Franks, Julian & Sussman, Oren, 2005. "Financial innovations and corporate bankruptcy," Journal of Financial Intermediation, Elsevier, vol. 14(3), pages 283-317, July.
    7. Aldo Montesano, 2009. "Risk allocation and uncertainty: some unpleasant outcomes of financial innovation," International Review of Economics, Springer, vol. 56(3), pages 243-250, September.
    8. Helios Herrera & Enrique Schroth, 2005. "Developer's Expertise and the Dynamics of Financial Innovation: Theory and Evidence," Working Papers 0504, Centro de Investigacion Economica, ITAM.
    9. Lerner, Josh, 2006. "The new new financial thing: The origins of financial innovations," Journal of Financial Economics, Elsevier, vol. 79(2), pages 223-255, February.
    10. Lewis, Craig M. & Verwijmeren, Patrick, 2011. "Convertible security design and contract innovation," Journal of Corporate Finance, Elsevier, vol. 17(4), pages 809-831, September.
    11. Herrera, Helios & Schroth, Enrique, 2011. "Advantageous innovation and imitation in the underwriting market for corporate securities," Journal of Banking & Finance, Elsevier, vol. 35(5), pages 1097-1113, May.
    12. Henderson, Brian J. & Pearson, Neil D., 2011. "The dark side of financial innovation: A case study of the pricing of a retail financial product," Journal of Financial Economics, Elsevier, vol. 100(2), pages 227-247, May.
    13. Hall, Bronwyn H. & Thoma, Grid & Torrisi, Salvatore, 2010. "Financial Patenting in Europe," MERIT Working Papers 011, United Nations University - Maastricht Economic and Social Research Institute on Innovation and Technology (MERIT).
    14. Kim, Teakdong & Koo, Bonwoo & Park, Minsoo, 2013. "Role of financial regulation and innovation in the financial crisis," Journal of Financial Stability, Elsevier, vol. 9(4), pages 662-672.
    15. Trauten, Andreas, 2004. "Zur Effizienz von Wertpapieremissionen über Internetplattformen," Working Papers 8, Competence Center Internet Economy and Hybrid Systems, European Research Center for Information Systems (ERCIS), University of Münster.

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