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Why Is The Profitability of Financial Innovation So Difficult to Identify? Innovation Clusters and Productive Opacity

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  • Kurt Dew

Abstract

The empirical literature identifying gains from financial innovation to financial institution stockholders is sparse. The literature identifying financial firms’ contributions to stockholder value resulting from long term commitment to innovation is, to our knowledge, nonexistent. Several authors note that the protection of financial engineering innovations from imitation is particularly challenging. We consider the implications for the structure of financial innovation, proposing a stylized representation of the innovative process called 'the cluster hypothesis.' Under the hypothesis, innovations occur in symbiotic collections of transparent 'external innovations,' together with opaque 'internal innovations.' Only the latter provide economic rents. We find evidence that innovation-induced opacity drives long run relative rewards at added risk for financial institution stockholders.

Suggested Citation

  • Kurt Dew, 2006. "Why Is The Profitability of Financial Innovation So Difficult to Identify? Innovation Clusters and Productive Opacity," NFI Working Papers 2006-WP-12, Indiana State University, Scott College of Business, Networks Financial Institute, revised Apr 2007.
    • Handle: RePEc:nfi:nfiwps:2006-wp-12
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    References listed on IDEAS

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    1. Tufano, Peter, 1989. "Financial innovation and first-mover advantages," Journal of Financial Economics, Elsevier, vol. 25(2), pages 213-240, December.
    2. Miller, Merton H., 1986. "Financial Innovation: The Last Twenty Years and the Next," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 21(4), pages 459-471, December.
    3. Josh Lerner, 2002. "Where Does State Street Lead? A First Look at Finance Patents, 1971 to 2000," Journal of Finance, American Finance Association, vol. 57(2), pages 901-930, April.
    4. Edward J. Kane, 2000. "Incentives for banking megamergers: what motives might regulators infer from event-study evidence?," Proceedings, Federal Reserve Bank of Cleveland, pages 671-705.
    5. 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.
    6. Robert C. Merton, 1992. "Financial Innovation And Economic Performance," Journal of Applied Corporate Finance, Morgan Stanley, vol. 4(4), pages 12-22, January.
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