The Ancient Roots of Modern Financial Innovation: The Early History of Regulatory Arbitrage

Abstract:     
Recent years have seen an explosion of financial innovation. Much of this innovation seeks to exploit inconsistencies in the regulatory environment, and one of the most popular techniques for doing so uses put-call parity. Nonetheless, regulatory arbitrage using put-call parity is not a new phenomenon, as is frequently suggested. This Essay traces the use of put-call parity to avoid the usury prohibition back to Ancient Israel. It also describes the important role that put-call parity played in developing the equity of redemption, the defining characteristic of a modern mortgage, in Medieval England. In addition, this Essay describes how Muslims living in the West are using mortgage substitutes based on put-call parity to avoid Islam's prohibition on paying interest.

Keywords: financial innovation, put-call parity, regulatory arbitrage, financial history, usury

JEL Classifications: G18, G21, G29, K42, N20, O15

Working Paper Series