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Does Financial Innovation Enhance or Inhibit Real Innovation?

Posted: 2 Dec 2016 Last revised: 6 Nov 2017

Lora Dimitrova

University of Exeter

Sapnoti K. Eswar

University of Cincinnati - Department of Finance - Real Estate

Date Written: January 14, 2017

Abstract

We present evidence that financial innovation plays a role in increasing the level of real, innovative activity. We focus on non-financial firms' innovation performance, measured by patent-based metrics, and employ an exogenous change in the market for over-the-counter (OTC) derivatives in 1987. Distance from financial centers is used as an instrument for the likelihood of derivatives use. We find that firms with higher likelihood of derivatives use innovate more and have higher quality of innovations. The relationship is stronger for firms that are more likely to have an existing relationship with dealers or banks. Furthermore, we find that these results are driven by a greater ability of financially-constrained firms to invest in more risky ventures such as innovative projects.

Keywords: Innovation, Derivatives, Distance, Relationship banking, Financial constraints

JEL Classification: G31, G32, O31

Suggested Citation

Dimitrova, Lora and Eswar, Sapnoti K., Does Financial Innovation Enhance or Inhibit Real Innovation? (January 14, 2017). Available at SSRN: https://ssrn.com/abstract=2878698

Lora Dimitrova (Contact Author)

University of Exeter ( email )

Northcote House
The Queen's Drive
Exeter, Devon EX4 4QJ
United Kingdom

Sapnoti Eswar

University of Cincinnati - Department of Finance - Real Estate ( email )

College of Business Administration
Cincinnati, OH 45221
United States

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