Example research essay topic: Nineteenth Century Foreign Exchange - 971 words

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Innovation in finance, as in other fields, involves responses to particular problems. Nevertheless, discussion frequently focuses on various more general forces, giving an impetus to innovation such as the incentives resulting from regulation, improvements in communications and computer technology, increased financial volatility, greater competition in the financial sector, advances in academic financial research, and so on [Marshall and Bansal 1992, chap. 2; BIS 1986 ]. My remarks are not intended to cast doubt on the importance of these broad forces, but rather to point to certain relations between them which, I hope, will illuminate parts of what follows. Consider regulation. For financial innovation, regulation has a Janus-like quality: particular regulations do often provide incentives for financial innovation, but regulatory assent is also necessary for the actual introduction of innovations, and an accommodating regulatory framework is part and parcel of their feasibility and success. Consider an example outside the field of derivatives, the Eurocurrency market.

Regulatory restrictions on U. S. banks did contribute to the growth of this market [e. g. , Server 1988, chap. 23 ]. But Eurocurrency operations also require the permission or acquiescence of the regulatory authorities both of the country where they take place and of the countries whose currencies are used. More specifically, Eurocurrency operations are performed only in countries that permit banks to bid for foreign currency deposits and to make foreign currency loans both to each other and to non-residents, and only in the currencies of countries that allow foreign banks to keep and transfer deposits with their domestic banks and that permit external convertibility of these currencies [Graaf 1991, 3 ].

Similar remarks apply by and large to regulatory assent in the case of derivatives. Approval of exchange-traded derivatives involves the exchange itself and the regulatory body responsible for it. Over-the-counter (OTC) derivatives, customized instruments issued to particular clients, are subject to the jurisdiction of the body regulating the issuing institution. This is likely to leave certain end-users of derivatives, such as non-financial corporations, largely or completely outside the regulatory framework. But although lacunae of this kind are of concern to policymakers [see U.

S. GAO 1994, chaps. 5 and 7 ], the resulting unregulated spaces are unlikely to be the location of much innovation in derivative instruments. (These observations should not be taken to imply that regulatory frameworks for derivatives are uniformly effective. My sequel indeed will illustrate that this is far from being true. ) With respect to financial innovation generally, and that affecting derivatives more particularly, the enabling impact of improvements in communications and computer technology is always stressed. But rather less attention is paid to the institutions and knowledge on which these improvements impinge. The financial sector has historically been a repository of vast knowledge of techniques for managing the risks associated with its operations. This knowledge has included ways of unbundling risks (often through the creation of instruments which can also be used for speculation).

As a result, the sector's response to the effects of reductions in the costs of information and computation has been rapid. The pace of innovation has also benefitted from a willingness on the part not only of product designers in banks themselves, but also of academic financial researchers to explore the potential of concepts closely linked to actual financial practice. This interaction between activities such as trading and the generation of more systematic knowledge seems to me an analogue for finance similar processes for crafts and skills more generally, on the one hand, and science, on the other, whose fruitfulness has been emphasized, for example, by John Dewey and by members of the radical science movement in Britain in the earlier part of this century [e. g. , Dewey 1982, 73 - 74; Bernal 1971, 49 - 50 ]. One last introductory point I should like to make concerns the way in which one set of innovations involving derivatives is capable of opening the way for others.

This depends crucially on the development of markets for derivatives, owing to the way in which such markets make it possible for participants to lay off risks, including those associated with new instruments. The point can be illustrated for OTC derivatives. The exposure of dealers in the more complex OTC instruments now common, which combine features of different generic derivatives, can be disaggregated into their constituent risks, which are then laid off through the taking of offsetting positions in derivatives as well as other financial assets through trading on exchanges or transactions in other simpler OTC instruments in the interbank market. (1) Derivative Instruments Some derivatives have a long history, while others are of more recent origin. Forward contracts, that is to say, contracts for deferred delivery, were used for transactions on organized markets at least as early as those of medieval and Renaissance Europe. Alongside of the use of such contracts in the trading of goods, even then there was also speculation on foreign exchange rates by methods resembling derivatives.

For example, wagers were made on foreign exchange rates at Spanish fairs in sixteenth-century Antwerp and were settled in a manner similar to the use of offsetting positions on modern futures exchanges [Ehrenburg 1928 ]. Futures evolved from forward contracts as progressive standardization of contract terms became possible, and with it greater transferability of contracts and ease of settlement. Rice trading in seventeenth-century Japan is often cited as furnishing the first historical example of a futures market in something like the modern sense [Alletzhauser 1990, 26 - 27; Teweles et al. 1974, 8 - 9 ]. OTC foreign exchange options were available in nineteenth-century Germany [Yeager 1976, 269 ]. During the period from the middle of the nineteenth century until the late 1960 s the expansion of futures and option trading on exchanges involved commodities. Financial derivatives, principally forward exchange contracts and share options, were m

Research essay sample on Nineteenth Century Foreign Exchange