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      The Consequences of Financial Innovation: A Counterfactual Research Agenda
      07 Apr 2011Working Paper Summaries

      The Consequences of Financial Innovation: A Counterfactual Research Agenda

      by Josh Lerner and Peter Tufano
      While financial innovation is often praised as a positive force for societal growth, it also takes much of the blame for the recent global financial crisis. In this paper, Harvard Business School professors Josh Lerner and Peter Tufano explore financial innovation and discuss how it differs from other types of innovation. Key concepts include:
      • Financial innovation is defined as the act of creating and then popularizing new financial instruments, as well as new financial technologies, institutions, and markets.
      • Economists initially tended to consider financial innovation in the same way that they consider manufacturing innovation. However, financial innovation differs from other types of new product development in several ways: predicting the social consequences of the innovation can be challenging, due to how interconnected the financial system is; the consequences of the innovation may change over time, due to the dynamic nature of the business; and new financial products and services are especially susceptible to regulation.
      • The researchers suggest several promising approaches for future research. These include using counterfactual "thought experiments" to explore systemic impacts; looking at settings where there are big constraints on financial innovation, such as sharia-compliant financial structures; using experimental techniques; and studying the social impact of financial innovation using the same tools used to analyze the impact of new products.
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      Author Abstract

      Financial innovation has been both praised as the engine of growth of society and castigated for being the source of the weakness of the economy. In this paper, we review the literature on financial innovation and highlight the similarities and differences between financial innovation and other forms of innovation. We also propose a research agenda to systematically address the social welfare implications of financial innovation. To complement existing empirical and theoretical methods, we propose that scholars examine case studies of systemic (widely adopted) innovations, explicitly considering counterfactual histories had the innovations never been invented or adopted.

      Paper Information

      • Full Working Paper Text
      • Working Paper Publication Date: February 2011
      • HBS Working Paper Number: NBER Working Paper Series, No. 16781
      • Faculty Unit(s): Finance; Entrepreneurial Management
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      Josh Lerner
      Josh Lerner
      Jacob H. Schiff Professor of Investment Banking
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      Peter Tufano
      Peter Tufano
      Sylvan C. Coleman Professor of Financial Management, Emeritus
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