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Profitable Innovation Without Patent Protection: The Case of Derivatives

Author

Listed:
  • 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.

Suggested Citation

  • Helios Herrera & Enrique Schroth, 2003. "Profitable Innovation Without Patent Protection: The Case of Derivatives," FAME Research Paper Series rp76, International Center for Financial Asset Management and Engineering.
  • Handle: RePEc:fam:rpseri:rp76
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    References listed on IDEAS

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    1. Reinganum, Jennifer F, 1983. "Uncertain Innovation and the Persistence of Monopoly," American Economic Review, American Economic Association, vol. 73(4), pages 741-748, September.
    2. Tufano, Peter, 1989. "Financial innovation and first-mover advantages," Journal of Financial Economics, Elsevier, vol. 25(2), pages 213-240, December.
    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 1069-1087, September.
    4. Peter Tufano, 1995. "Securities Innovations: A Historical And Functional Perspective," Journal of Applied Corporate Finance, Morgan Stanley, vol. 7(4), pages 90-104.
    5. Boldrin, Michele & Levine, David K., 2008. "Perfectly competitive innovation," Journal of Monetary Economics, Elsevier, vol. 55(3), pages 435-453, April.
    6. Douglas W. Diamond, 1991. "Debt Maturity Structure and Liquidity Risk," The Quarterly Journal of Economics, Oxford University Press, vol. 106(3), pages 709-737.
    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. Jean-Pierre Benoit, 1985. "Innovation and Imitation in a Duopoly," Review of Economic Studies, Oxford University Press, vol. 52(1), pages 99-106.
    9. 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.
    10. Fama, Eugene F., 1985. "What's different about banks?," Journal of Monetary Economics, Elsevier, vol. 15(1), pages 29-39, January.
    11. 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.
    12. 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.
    Full references (including those not matched with items on IDEAS)

    Citations

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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.
    2. Michele Boldrin & David K Levine, 2008. "Quality Ladders, Competition and Endogenous Growth," 2008 Meeting Papers 277, Society for Economic Dynamics.
    3. Diego Comin, 2004. "R&D: A Small Contribution to Productivity Growth," Journal of Economic Growth, Springer, vol. 9(4), pages 391-421, December.
    4. 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.
    5. David Encaoua & Dominique Guellec & Catalina Martínez, 2010. "Sistemas de patentes para fomentar la innovación: Lecciones de análisis económico," Working Papers 1015, Instituto de Políticas y Bienes Públicos (IPP), CSIC.
    6. Chiara Oldani, 2005. "An Overview of the Literature about Derivatives," Macroeconomics 0504004, EconWPA.
    7. 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.
    8. repec:hal:journl:halshs-00743037 is not listed on IDEAS

    More about this item

    Keywords

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

    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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