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

  • Helios Herrera
  • Enrique Schroth

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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Paper provided by UCLA Department of Economics in its series Levine's Bibliography with number 784828000000000290.

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Date of creation: 19 Aug 2005
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Handle: RePEc:cla:levrem:784828000000000290
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  1. 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.
  2. Boldrin, Michele & Levine, David, 2002. "Perfectly Competitive Innovation," CEPR Discussion Papers 3274, C.E.P.R. Discussion Papers.
  3. Josh Lerner, 2004. "Where Does State Street Lead? First Look at Finance Patents, 1971-2000," Levine's Working Paper Archive 122247000000000497, David K. Levine.
  4. Tufano, Peter, 1989. "Financial innovation and first-mover advantages," Journal of Financial Economics, Elsevier, vol. 25(2), pages 213-240, December.
  5. 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.
  6. Peter Tufano, 2003. "Financial Innovation," Levine's Working Paper Archive 618897000000000651, 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. Peter Tufano, 1995. "Securities Innovations: A Historical And Functional Perspective," Journal of Applied Corporate Finance, Morgan Stanley, vol. 7(4), pages 90-104.
  9. 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.
  10. 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 939-67.
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