An Evolutionary Approach to Financial Innovation
Zurich IEER Working Paper No. 35
39 Pages Posted: 26 Jul 2000
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: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Multicountry, Multifactor Tests of the Factor Abundance Theory
By Harry P. Bowen, Edward E. Leamer, ...
-
Monopolistic Competition and International Trade: Reconsidering the Evidence
-
Bilateralism and Regionalism in Japanese and U.S. Trade and Direct Foreign Investment Patterns
By Jonathan Eaton and Akiko Tamura
-
Continental Trading Blocs: Are They Natural, or Super-Natural?
By Jeffrey A. Frankel, Ernesto Stein, ...
-
Trade and Search: Social Capital, Sogo Shosha, and Spillovers
-
The Gatt's Contribution to Economic Recovery in Post-War Western Europe
-
The Geography of Intra-Industry Trade: Empirics
By Patricia Rice, Martin Stewart, ...
-
Comparative Advantage, Exchange Rates, and G-7 Sectoral Trade Balances