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Profitable Innovation Without Patent Protection: The Case of Derivatives

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Author Info

  • Helios Herrera

    (ITAM)

  • Enrique Schroth

    (HEC Lausanne and FAME)

Abstract

Investment banks find it profitable to invest in the development of innovative derivative securities even without being able to preclude early competition from other investment banks using patents. To explain this, we assume that the developer can learn from the first issues of the innovative financial product and is able to become the expert issuer by the time imitation enters the market. We show how this becomes an informational first-mover advantage that turns innovators into the market leader. It is this advantage, and not the typical temporary monopoly position awarded to a patent holder, that provides the incentive to pay the development costs. In the aftermath, the innovator ends up with the largest share of the underwriting market and makes positive profits. Our model’s predictions are consistent with many stylized facts of financial innovations by investment banks.

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Bibliographic Info

Paper provided by International Center for Financial Asset Management and Engineering in its series FAME Research Paper Series with number rp76.

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Date of creation: Jan 2003
Date of revision:
Handle: RePEc:fam:rpseri:rp76

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Related research

Keywords: Financial innovation; first-mover advantages; asymmetric information; learning-by-doing;

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References

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  1. Fama, Eugene F., 1985. "What's different about banks?," Journal of Monetary Economics, Elsevier, vol. 15(1), pages 29-39, January.
  2. Michele Boldrin & David K Levine, 2002. "Perfectly Competitive Innovation," Levine's Working Paper Archive 625018000000000192, David K. Levine.
  3. Sharpe, Steven A, 1990. " Asymmetric Information, Bank Lending, and Implicit Contracts: A Stylized Model of Customer Relationships," Journal of Finance, American Finance Association, vol. 45(4), pages 1069-87, September.
  4. Miller, Merton H., 1986. "Financial Innovation: The Last Twenty Years and the Next," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 21(04), pages 459-471, December.
  5. Benoit, Jean-Pierre, 1985. "Innovation and Imitation in a Duopoly," Review of Economic Studies, Wiley Blackwell, vol. 52(1), pages 99-106, January.
  6. Josh Lerner, 2004. "Where Does State Street Lead? First Look at Finance Patents, 1971-2000," Levine's Working Paper Archive 122247000000000497, David K. Levine.
  7. Bhattacharyya, Sugato & Nanda, Vikram, 2000. "Client Discretion, Switching Costs, and Financial Innovation," Review of Financial Studies, Society for Financial Studies, vol. 13(4), pages 1101-27.
  8. Diamond, Douglas W, 1991. "Debt Maturity Structure and Liquidity Risk," The Quarterly Journal of Economics, MIT Press, vol. 106(3), pages 709-37, August.
  9. Peter Tufano, 1995. "Securities Innovations: A Historical And Functional Perspective," Journal of Applied Corporate Finance, Morgan Stanley, vol. 7(4), pages 90-104.
  10. Reinganum, Jennifer R., 1982. "Uncertain Innovation and the Persistence of Monopoly," Working Papers 431, California Institute of Technology, Division of the Humanities and Social Sciences.
  11. Enrique Schroth, 2002. "Innovation and First-Mover Advantages in Corporate Underwriting: Evidence from Equity Linked Securities," FAME Research Paper Series rp74, International Center for Financial Asset Management and Engineering.
  12. Tufano, Peter, 1989. "Financial innovation and first-mover advantages," Journal of Financial Economics, Elsevier, vol. 25(2), pages 213-240, December.
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Citations

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Cited by:
  1. David Encaoua & Dominique Guellec & Martinez Catalina, 2011. "Sistemas de patentes para fomentar la innovacion: lecciones de analisis economico," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00743037, HAL.
  2. Michele Boldrin & David K. Levine, 2002. "Perfectly competitive innovation," Staff Report 303, Federal Reserve Bank of Minneapolis.
  3. repec:hal:journl:halshs-00743037 is not listed on IDEAS
  4. Chiara Oldani, 2005. "An Overview of the Literature about Derivatives," Macroeconomics 0504004, EconWPA.
  5. Michele Boldrin & David K Levine, 2010. "Quality Ladders, Competition and Endogenous Growth," Levine's Working Paper Archive 661465000000000028, David K. Levine.
  6. Diego Comin, 2004. "R&D: A Small Contribution to Productivity Growth," Journal of Economic Growth, Springer, vol. 9(4), pages 391-421, December.
  7. repec:hal:journl:halshs-00177614 is not listed on IDEAS
  8. Boldrin, Michele & Levine, David K., 2005. "Innováció - a verseny szemszögéből
    [Innovation: the competitive view]
    ," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(6), pages 537-555.
  9. repec:hal:cesptp:halshs-00177614 is not listed on IDEAS
  10. Encaoua, David & Guellec, Dominique & Martinez, Catalina, 2006. "Patent systems for encouraging innovation: Lessons from economic analysis," Research Policy, Elsevier, vol. 35(9), pages 1423-1440, November.

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