A MATHEMATICAL MODEL FOR FINANCIAL INNOVATION: EMPIRICAL EVIDENCE FROM FINANCIAL MARKETS

Dionisis Th. Philippas
Department of Business Administration, University of Patras
April, 2011
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Abstract

Financial innovation is an important research topic modern economics. Financial innovation is an ongoing process where new financial products, services and procedures are created and it concerns important financial factors such as the regulatory restrictions, the relationship between financial innovation and the functionality of financial markets, the inefficiency of markets promoted by globalization and unexpected changes of economic status and financial intermediary. The previous literature that deals with financial innovation is relatively constrained compared to the significance of the issue, which is a surprise considering the relative abundance of such research on other sectors of finance and economics. The consequences of financial innovations concern the functional framework of capital markets, the microeconomic and the macroeconomic functional frameworks. This thesis studies the influence of diffusion of financial innovation to market participants‟ frictions and their values, through a theoretical, mathematical and empirical framework. We derive a novel measure of the influence of financial innovation to the market participants based on their correlation friction patterns. The main objective is to highlight a number of aspects and dimensions of this field. In particularly, we aim to present: i) the theoretical framework on the role of financial innovation at the financial structure (the fundamental generating root causes and the effects on the function of financial markets, etc), and ii) the parameterization of the influence of financial innovation to market participants through a mathematical and econometric framework based on the participants‟ minimum need for change, the diffusion rate and time parameter. We undertake an extensive empirical analysis about the influence of introduction and diffusion of a financial innovation to market participants. The findings lead us to the conclusion that the parametric function, which is followed in order to show the influence of diffusion of financial innovation, has a statistically significant impact on
returns and volatility of financial and economic indices.