Knowledge, Technology Adoption and Financial Innovation

Abstract

Why are new financial instruments created? This paper proposes the view that financial development arises as a response to the contractual needs of emerging technologies. Exogenous technological progress generates a demand for new financial instruments in order to share risk or overcome private information, for example. A model of the dynamics of technology adoption and the evolution of financial instruments that support such adoption is presented. Early adoption may be required for financial markets to learn the technology; once learned, financial innovation boosts adoption further. Financial learning emerges as a source of technological diffusion. The analysis identifies a causality link from technology to growth which is nonetheless consistent with empirical findings of a positive effect of current financial development on future growthTechnology adoption; financial innovation; learning