An Evolutionary Approach to Financial Innovation

Zurich IEER Working Paper No. 35

39 Pages Posted: 26 Jul 2000

See all articles by Marc Oliver Bettzuge

Marc Oliver Bettzuge

University of Zurich - Department of Economics; McKinsey & Co. Inc.

Thorsten Hens

University of Zurich - Department of Banking and Finance; Norwegian School of Economics and Business Administration (NHH); Swiss Finance Institute

Date Written: March 2000

Abstract

The purpose of this paper is to explain why some markets for financial products take off while others vanish as soon as they have emerged. To this end, we model an infinite sequence of CAPM-economies in which financial products can be used for insurance purposes. Agents' participation in these financial products, however, is restricted. Consecutive stage economies are linked by a mapping ("transition function") which determines the next period's participation structure from the preceding period's participation. The transition function generates a dynamic process of market participation which is driven by the percentage of informed traders and the rate at which a new asset is adopted. We then analyze the evolutionary stability of stationary equilibria. In accordance with the empirical literature on financial innovation, it is obtained that the success of a financial innovation, a mutation, depends on a sufficiently high trading volume, marketing, and new and differentiated hedging opportunities. In particular, a set of complete markets forming a stationary equilibrium is robust with respect to any further financial innovation while this is not necessarily true for a set of incomplete markets.

Keywords: Financial Innovation, Evolution, GEI, CAPM

JEL Classification: D52, G10, O31

Suggested Citation

Bettzuge, Marc Oliver and Hens, Thorsten, An Evolutionary Approach to Financial Innovation (March 2000). Zurich IEER Working Paper No. 35. Available at SSRN: https://ssrn.com/abstract=229055 or http://dx.doi.org/10.2139/ssrn.229055

Marc Oliver Bettzuge

University of Zurich - Department of Economics

Zuerich, 8006
Switzerland

McKinsey & Co. Inc.

Konigsallee 60C
K-40027 Dusseldorf, Quebec
Germany

Thorsten Hens (Contact Author)

University of Zurich - Department of Banking and Finance ( email )

Plattenstrasse 32
Zurich, 8032
Switzerland
+41-44 634 37 06 (Phone)

Norwegian School of Economics and Business Administration (NHH)

Helleveien 30
Bergen, 5045
Norway

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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