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The Welfare Implications of Non-Patentable Financial Innovations

Author

Listed:
  • Helios HERRERA

    (ITAM- Centro de Investigacion Economica)

  • Enrique SCHROTH

    (HEC-University of Lausanne and FAME)

Abstract

Investment Banks invest in R&D to design innovative securities even when imitation is possible, i.e., when innovations cannot be patented. We show how a financial institution can profit from the development of financial products even if they are unpatentable. For certain types of financial products innovating investment banks have an information advantage over imitators. This information advantage makes them better competitors and market leaders. The mere possibility of costless imitation drives innovators’ profits down, but still keeps them positive. The absence of patents allows part of the surplus generated by the innovation to be allocated to investors. The extent of surplus sharing depends on the degree of asymmetry in the information owned by imitators and innovators and on the total number of innovators. The larger this asymmetry, the higher the innovator’s profits and the lower the investor’s surplus. With more than one innovator all the surplus goes to investors.

Suggested Citation

  • Helios HERRERA & Enrique SCHROTH, 2001. "The Welfare Implications of Non-Patentable Financial Innovations," FAME Research Paper Series rp82, International Center for Financial Asset Management and Engineering.
    • Handle: RePEc:fam:rpseri:rp82
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    File URL: http://www.swissfinanceinstitute.ch/rp82.pdf
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    References listed on IDEAS

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    1. Tufano, Peter, 1989. "Financial innovation and first-mover advantages," Journal of Financial Economics, Elsevier, vol. 25(2), pages 213-240, December.
    2. Miller, Merton H., 1986. "Financial Innovation: The Last Twenty Years and the Next," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 21(4), pages 459-471, December.
    3. Jean Tirole, 1988. "The Theory of Industrial Organization," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200716, April.
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    Cited by:

    1. Yuan K. Chou, 2004. "Technological Revolutions and Financial Innovations," Department of Economics - Working Papers Series 901, The University of Melbourne.
    2. Yuan K. Chou, 2003. "A Pedagogical Tool For Illustrating The Real Impact Of The Financial Sector," Department of Economics - Working Papers Series 888, The University of Melbourne.
    3. Yuan K. Chou & Martin S. Chin, 2004. "Opening The Financial Sector To Foreign Competition: Assessing The Dynamic Macroeconomic Consequences Using A Two-Sector Growth Model," The Singapore Economic Review (SER), World Scientific Publishing Co. Pte. Ltd., vol. 49(02), pages 195-224.

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    More about this item

    Keywords

    Financial innovation; imperfect imitation; patents;
    All these keywords.

    JEL classification:

    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • L12 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Monopoly; Monopolization Strategies
    • K20 - Law and Economics - - Regulation and Business Law - - - General

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