Financial Innovation in Asia and Europe

14 Pages   |   3,498 Words

Research Proposal
Financial Innovation in Asia and Europe: A Comparative Study 

Table of Contents

Background. 3
Features of Financial Innovation in Europe and Asia. 5
Industry Background. 8
Research Aims. 9
Research Questions. 9
Research Hypothesis. 9
Research Objectives. 9
Research Methodology. 10
Secondary Research Analysis. 10
Expert Interviews. 11
Survey Analysis. 11
Research Strategy. 11
Timescale. 12
Resources. 12
Conclusion. 13
References. 13 Financial innovation is among the most debated concept in contemporary disciplines of economics and finance. Research in the area of financial innovation has become important for adequate adoption of financial innovation determines both the growth and recessionary cycles in an economy. For instance, the Global Financial Recession of 2007 is ascribed to adoption of inappropriate financial innovation in US consumer markets. The repercussions of the economic recession which resulted were felt across Europe and some of the effects lingered for two years. Financial innovation is taking place simultaneously in various financial markets round the world including US, Europe and Asian region. In fact, due to globalization of commerce and trade, financial innovation runs parallel in different regions of the world and it is interrelated.

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There are differences in financial innovations associated with Asian and Europe markets. (ref) categorize financial innovation as ‘aggressive’ or ‘defensive’. This classification is based on functional basis of the financial instrument (Franks and Sussman, 2005). Financial innovation in European markets is described as aggressive because it is based on creation of a new product concept or process. On the other hand, financial innovation associated with Asian markets is more on the side of defensive innovation. Defensive innovation in Asian equity and debt markets is largely in response to changed environment or motivated by the objective of reducing transaction cost.
It is important to understand the four fundamental factors on which financial innovations are based before attempting to understand differences between financial innovations in European and Asian regions. Financial innovations are basically an outcome of four interrelated factors. Foremost among these factors are interest rates and inflation rates variation in the economies. As interest rates and inflation rates in an economy changes, the needs of investors also change. New financial instruments save investors from changes in interest and inflation rates in such environment (Wonglimpiyarat, 2011). Since, the macroeconomic variables of different countries are dependent on the growth rates and governmental policies, financial innovations differ across markets. It is unreasonable to presume that the rate and form of financial innovation will face the same change across the globe.
Secondly, level of technology implementation is the factor leading to financial innovation. Several financial instruments have only become possible after introduction of a new technology took place in the financial markets (Hyytinen and Toivanen, 2005). The development of innovative technology can encourage financial innovation by reducing the cost of providing new financial services and instruments through the use of computers and telecommunication technologies. Since, the rate of technology adoption in different across markets, introduction and adoption of new financial instruments have differed similarly.   
Perhaps the most important factor on which financial innovation is dependent is changes in regulatory environment of a region. In fact, the correlation between regulation and innovation is amongst the highest debated topics in contemporary literature (Wonglimpiyarat, 2011). It is apparent that financial innovation is restricted by regulation; however, it is not clear whether regulation has adequately been able to keep check on financial innovation harmful to interests of consumers. The fourth factor is market determinant specific variables. The sophistication of consumer demand differs for each type of market. Investors in some markets are much more risk averse than others. Firms offer those financial products which they think will be demanded by the consumers.
The driver of financial innovation in all markets across the globe is that agents in market are seeking methods to make higher profits and to differentiate themselves. It is not uncommon to find different investments sold as a bundle to investors in the form of an investment with insurance cover. Also, investors’ needs are also quite complex  (Hyytinen and Toivanen, 2005). In a theoretical market, investors would either be interested in either high-risk and high-return investment or low-risk and low-return one. However, in real life scenarios consumers are seeking a proportion of low risk of bonds and a portion of high return of equity investments. This creates an opportunity for investment companies to fulfill this market gap by offering an amalgamation of two different types of securities. The net outcome is both growth and safety for investors while increased utilization of expert advice of fund managers.
Interestingly, certain theorists of contemporary era posits that if the investors were able to purchase securities that pay off readily then there would be no need for financial innovation. Financial innovation is only driven by the wish of investors to combine securities to create portfolios to have whatever payoff they desire. Several researchers have also elaborated on the question of why certain forms of financial innovation are well received in the market compared to others. Henderson and Pearson (2011) discussed at length the utility and efficiency implications of financial innovation. It is also recognized by several researchers that financial era is directly proportional to technological advancement in a region. Improvements in computer and telecommunication technologies are cited as the harbinger for one the most ubiquitous financial innovation contemporary times – the ATM. ATM is a financial innovation which is based on the principle of asset-backed securitization.. Similar ubiquitous financial innovations of this generation are credit cards, debit cards and Paypal. The success of the above mentioned financial innovation is attributed to the quality that it greatly reduces transaction costs and provides freedom to households to maintain possession of cash balances. In view of other analysts, the real value provided by these financial instruments is that an individual is able to maintain large percentages of their wealth in non-cash instruments. Financial innovation is also described as an outcome of the interaction between of electronic commerce and central banking.  Financial innovation has been found to be positively correlated with economic growth of a region. Hence, the importance of this research is magnified  (Hyytinen and Toivanen, 2005). Adequate provision for financial innovation can lead to economic growth in a region, while inadequate one can cause financial problems like the financial crisis of 2007–2010.
Features of Financial Innovation in Europe and Asia Financial innovation has been readily taking place in both Europe and Asia, though the pace and form of innovation had differed between the two regions. Inflation in Asian countries has been much more variable and unpredictable. On the other hand, Europe is characterized by highly stable economy and growth rates. The growth rate of European economies has been low compared to Asian countries, yet their inflation was also in control as compared to Asian countries  (Hyytinen and Toivanen, 2005). This is the reason that new financial instruments which were introduced in Asian region were designed to offer protection against changes in financial environment, variations in exchange rates of the currency and interest rates set by the government. On the other hand, government deficits are burgeoning in European markets which an indication of mounting debt on government. It is no wonder that recent innovations in financial markets of European countries were designed to investments in growing economies and to shift the risk away from solvency of European governments.
Adoption of novel technology has been much quicker in European markets as compared to their Asian counterparts. For instance, European economies were much more agile in adopting trading of securities and instruments over the internet. This innovation improved the responsiveness of the market to information changes much quicker. Therefore, markets became much more efficient and financial instruments more transparent  (Hyytinen and Toivanen, 2005). Asian markets are still in the process of adopting the financial innovations which were adopted by European markets much earlier. Europe leaded innovation in financial sector along with US due to its rapid development of technology in the financial sector, improvements in communication infrastructure and rapid information flow. In the area of financial regulation, there is a growing debate among researchers whether Europe or Asian countries lead in terms of effective regulations. Traditionally it has been widely believed that European markets are much more efficient than those in developing countries due to stringent regulations imposed on them by regulatory authorities. This supposition turned out to be largely incorrect following the financial meltdown in European region  (Hyytinen and Toivanen, 2005). The responsibility of this meltdown was placed on oversight of regulatory authorities of European region and irresponsible financial innovation was declared culprit of economic slash faced by European region as a whole. Nevertheless, European markets have become quite conservative in terms of financial innovation in the post 2008 era. Financial innovation is also driven by consumer needs in European market where young investors are on the lookout for high return investments.  
There is also a time lag between financial innovation in European region and Asian countries. During the era of 1960’s individuals and financial institutions which operated in European markets faced drastic changes in economic environment and rate of inflation. During this era, interest rates increased rapidly and investors found that the rate of return on their investments is very low when compared to inflation in the economy  (Hyytinen and Toivanen, 2005). There was a general awareness in the market regarding the inadequacy of existing instruments which were being offered in the market by different investment firms. This instigated the creation of new financial instruments which were not fixed in terms of rate of return. Rather the rate of return of these instruments was tied to the prevailing interest rate in the economy. This creation of variable-rate debt instruments was in the form of certificates of deposits, mortgages and even formation of futures market for financial instruments  (Hyytinen and Toivanen, 2005). The subsequent stage of this chain of financial innovation was creation of an options market for debt instruments. Similar innovation in financial instruments was brought into the Asian markets during late 1980’s and early 1990’s. This exhibits the aforementioned time lag between similar innovations in Asian and European markets.
European also lead financial innovation which was driven by technological developments. Asian markets were much slow in catching up to technology driven financial innovation. When information technology was merged with investment markets, new products which were created in European markets were negotiable order of withdrawal account, certificate of deposits, banks credit cards and mortgages (Wonglimpiyarat, 2011). Each one of these was adopted by Asian markets after a considerable time. Banking sector of Europe was also quick to understand consumer needs and offered automatic transfer accounts, overnight repurchase agreements, Eurodollars, commercial papers and money market mutual funds. Asian markets and financial institutions lagged behind in this form of financial innovation driven by consumer needs and technological developments.
Degree of taxation is also a difference between European and Asian markets. Several theorists have also confirmed the importance of taxation for determination of financial innovation in different markets in the world (Wonglimpiyarat, 2011).  The Modigliani-Miller theorem states that there are two factors which lead to differences in offering in financial instruments; namely, taxes and regulations. These two factors which determinant in decision making of investors to among different forms of financial instruments. The theorem also asserts that the arrangement of a company’s liabilities have no impact on its net worth. Taxation is much more stringent in European markets, and for this reason the propensity of investors in European markets is for those instruments which provide coverage against tax expenses or defer tax expense to some other period of time. There is a demand for specific type of securities in the European markets. In the Asian markets, reason for taxation does not hold true. The capital asset pricing model of
Markowitz also predicts the kind of financial innovation which will take place in each market (Hyytinen and Toivanen, 2005). The theorem states that the investors should seek to completely diversify holding of their portfolios between a combination of "market" and a risk-free investment. Risk free invents in European markets are adequately represented by government bonds. Also, European stock markets are much more stable than stock exchanges in other countries. The situation does not hold true for several Asian markets where markets have crashed several times due to inadequacy in supporting infrastructure. The implication of this change is that in European brokerage firms have focused their financial innovation efforts towards leveraging the high rate of return to increase the ratio of the market return to the risk-free return in their portfolios (Wonglimpiyarat, 2011). Asian brokerage firms, on the other hand, have directed their efforts of market innovation by gaining assets of European economies. It is not uncommon to find financial instruments in Asian countries which contain a portion of the holding of Euro, US dollar or Pound Sterling.
Hyytinen and Toivanen (2005) has also pointed out that certain forms of financial innovations are already being accepted in financial markets of Asian region while it has long been discarded among investors of European countries. European investors no longer exhibit interest in financial instruments that only package existing risks differently. Rather, Europe is a comparatively sophisticated market for investment instrument and savers exhibit interest in instruments which opens up new types of investment opportunities. For example, financial instruments which enable an average investor to leverage home equity to gain investment exposure will be well received in European markets. Financial innovation is the process through which new financial products are introduced in the market for investment purposes. Some researchers also term repackaging of existing financial products as a form of financial innovation. The process of financial innovation is an on-going process which has been taking place since the formation of current economic system of paper currency and banking. Bankers and financial managers are constantly looking for ways to create new financial products. For the purpose of the research proposed in this submission, an all encompassing concept of financial innovation has been adopted.
Financial innovation is described as either a creation of a new financial instrument or an innovation in use of an existing financial instrument.  Outcomes of financial innovation is that it leads to shift in risk between borrower and lender, give issuer less costly ways to borrow funds and reduce risk associated with investment in a financial instrument. There are certain drawbacks of financial innovation, as well. The Credit Crunch of 2008 was sparked by innovative financial products. The aim of the study is to unravel the differences between financial innovation in European and Asian region. The objective is to carry out both comparison and contrast of the degree of financial innovation in the two markets. In contemporary times, the financial innovation possesses the potential to grow or destroy an economy. Impact of regulatory bodies is also evaluated to find suitability of financial innovation with the need of the economy and market. Study of financial innovation can provide the way to regulators and decisions makers to identify appropriate financial innovations from inappropriate ones. Also, it will contribute towards economic growth and greater integration among countries.    1. What are the differences in financial innovation between Asian and European countries?
2. Are there identifiable salient features of financial innovations which were successful in creating value for all stakeholders and lead to economic growth? Hypothesis One:  Financial innovation in Asian markets is much more aggressive than European markets
Hypothesis Two: Those financial innovations are successful in for the economic system and investors which are based on the fundamental principles of creating value according to disciplines of economics and finance 1. Find differences in financial innovation in European and Asian markets
2. Identify successful financial innovations from unsuccessful ones
3. To find common feature in economic and finance theory with recent financial innovations in European and Asian markets The study of financial innovation requires use of a holistic set of research tools. Both primary and secondary research methods are utilized in research design. Advanced methods of statistical analysis will be used for analysis of survey data.
Secondary Research Analysis Significant amount of research can be found on the topic of financial innovation and various markets. Europe has particularly been the subject of study in recent times. The objective of secondary research analysis is to gain knowledge from the input of the researches which have already been done on the topic. Secondary research also aids in refining the research problem and for giving direction to the research. The focus of the research will be much better identified through secondary research for gaps in existing knowledge will be found out.
Expert Interviews For a topic concerning financial innovation, interviews with knowledgeable individuals is integral to research design. Interviews are a qualitative method of research which involves in-depth interviews with a research participant. The interview is not entirely structured and involves considerable skill of the researcher to probe into various aspect of the research (Holloway, 1997). This method brings to light several aspects of the problem which were originally not part of the study.
 Online Survey Online survey is an integral part of research design. Online survey has the purpose of gaining understanding about the opinion of people regarding financial innovation in their country. Both European and Asian countries will be part of the sample population for online survey and comparisons will be made of the responses from the two regions.  The key benefit of online survey method in this study is that it is relatively inexpensive method to carry out research and the findings of the study can be generalized widely (Creswell, 1994). The plan of the research is to move from wide to a narrow area of focus. The expansive focus at the start of the research will make certain that all pertinent factors in the model of internet governance are taken into consideration. At later stages in the study, focus will be narrowed as the research problem will be prepared into a more focused area. Principles of validity and reliability are also going to be upheld during the course of the study. Control variables will be built into the research to account for extraneous variables. The proposed timescale for the research is given as under:
Research Schedule
Week Start Date : 1-12-2011
Week 1 2 3 4 5 6 7 8 9 10
Background reading & secondary research X X X              
Research design and plan   X                
In-depth interviews   X X X            
Case study analysis     X X            
Questionnaire design     X X X          
Survey data collection       X X X        
Data analysis  and refine           X X      
Qualitative analysis           X X      
Editing final document             X X    
Produce final document               X X  
Document passed to supervisor to read                   X
The source for secondary research analysis is composed of leading journal portals. Convenient sampling will be used for in-depth interviews to optimize use of resources. Travelling cost will be entailed for interviews. Cost of questionnaire will be saved by making an online questionnaire in HTML format. This questionnaire will be emailed to a sizeable database of email addresses. SPSS software will be employed for data analysis and for the process of hypothesis testing. Financial innovations have a significant role to play in contemporary economies. The proposed study will shed light on important and critical areas of study and will contribute towards economic growth in key regions around the globe. Barshefsky, C. (2001) 'Trade Policy for a Networked World', Foreign Affairs, pp. 134 -46.
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