Patenting and Licensing of Financial Innovations

Abstract

Recent court decisions, starting with the State Street decision in 1998, allow business methods to be patentable and now give financial institutions the option to seek patent protection for financial innovations. We develop a dynamic model that incorporates salient aspects of the adoption and dissemination of financial innovations. We find, somewhat surprisingly, that patent protection may be detrimental to long-term profits because of embedded real options for further innovations and market expansion that are especially important for financial firms. Moreover, a strategy of patenting and then licensing may not be effective because of expertise-related constraints of the licensees. Our framework helps understand the success of a wide class of innovations including swaps, credit derivatives, and pricing algorithms; it also helps financial institutions decide whether it is optimal to exercise the patentability and licensing option.

Keywords: Business Methods, Financial Innovations, Patents, Licenses, Real Options

JEL Classification: G20, L10, O31