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Developer's Expertise and the Dynamics of Financial Innovation: Theory and Evidence

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  • Helios Herrera
  • Enrique Schroth

Abstract

We study product innovation and imitation in the market of corporate underwriting with a dynamic model where client switching costs and the bankers' expertise in deal structuring characterize the life cycle of a security. While the clientele loyalty allows positive rent extraction, the superior expertise can account for the documented market leadership of the innovator. As expertise on product structuring is acquired by imitators, the innovator's market share advantage decreases. Also, the speed of entry by imitators increases for later generation products. Our predictions are consistent with well documented evidence on the market share leadership of innovators. We also present new evidence from equity-linked and derivative corporate products that supports the dynamic predictions of our learning model.
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Suggested Citation

  • Helios Herrera & Enrique Schroth, 2005. "Developer's Expertise and the Dynamics of Financial Innovation: Theory and Evidence," Levine's Bibliography 784828000000000290, UCLA Department of Economics.
  • Handle: RePEc:cla:levrem:784828000000000290
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    References listed on IDEAS

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    1. 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.
    2. Persons, John C & Warther, Vincent A, 1997. "Boom and Bust Patterns in the Adoption of Financial Innovations," Review of Financial Studies, Society for Financial Studies, vol. 10(4), pages 939-967.
    3. Tufano, Peter, 1989. "Financial innovation and first-mover advantages," Journal of Financial Economics, Elsevier, vol. 25(2), pages 213-240, December.
    4. Boldrin, Michele & Levine, David K., 2008. "Perfectly competitive innovation," Journal of Monetary Economics, Elsevier, vol. 55(3), pages 435-453, April.
    5. Peter Tufano, 1995. "Securities Innovations: A Historical And Functional Perspective," Journal of Applied Corporate Finance, Morgan Stanley, vol. 7(4), pages 90-104.
    6. Bhattacharyya, Sugato & Nanda, Vikram, 2000. "Client Discretion, Switching Costs, and Financial Innovation," Review of Financial Studies, Society for Financial Studies, vol. 13(4), pages 1101-1127.
    7. Josh Lerner, 2000. "Where Does State Street Lead? A First Look at Finance Patents, 1971-2000," NBER Working Papers 7918, National Bureau of Economic Research, Inc.
    8. Tufano, Peter, 2003. "Financial innovation," Handbook of the Economics of Finance,in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 6, pages 307-335 Elsevier.
    9. Peter Tufano, 2003. "Financial Innovation," Levine's Working Paper Archive 618897000000000651, David K. Levine.
    10. Enrique Schroth, 2006. "Innovation, Differentiation, and the Choice of an Underwriter: Evidence from Equity-Linked Securities," Review of Financial Studies, Society for Financial Studies, vol. 19(3), pages 1041-1080.
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    Cited by:

    1. Boldrin, Michele & Levine, David K., 2008. "Perfectly competitive innovation," Journal of Monetary Economics, Elsevier, vol. 55(3), pages 435-453, April.

    More about this item

    JEL classification:

    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • L12 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Monopoly; Monopolization Strategies
    • L89 - Industrial Organization - - Industry Studies: Services - - - Other

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