Does Financial Innovation Lead to Real Innovation? Evidence from Financial Derivatives

Abstract

We investigate whether financial innovation, specifically the introduction of derivative products, spurs firms’ real innovation, measured with patent based metrics. Consistent with financial innovation being an important contribution to real innovation, we find that the use of financial derivatives causes firm patent production to increase. The main mechanism behind the relationship is improved risk management. Derivatives usage decreases cash flow volatility, decreasing the need for external financing, and allowing firms to expand their innovative projects.

Keywords: Real innovation, FX derivatives, Risk management

JEL Classification: G31, G32, O31