Both markets are founded on the manipulation of symbols and
coded concepts. The dynamic of these markets is self-reinforcing.
Faster computers with more massive storage, speedier data transfer
("pipeline"), and networking capabilities - give rise to all forms of
advances - from math-rich derivatives contracts to distributed
computing. These, in turn, drive software companies, creators of
content, financial engineers, scientists, and inventors to a heightened
complexity of thinking. It is a virtuous cycle in which innovation
generates the very tools that facilitate further innovation.
The eminent American economist Robert Merton - quoted in Sigma 3/2001 -
described in the Winter 1992 issue of the "Journal of Applied Corporate
Finance" the various phases of the market-buttressed spiral of
financial innovation thus:
"1. In the first stage ... there is a proliferation of standardised
securities such as futures. These securities make possible the creation
of custom-designed financial products ...
2. In the second stage, volume in the new market expands as financial
intermediaries trade to hedge their market exposures.
3. The increased trading volume in turn reduces financial transaction
costs and thereby makes further implementation of new products and
trading strategies possible, which leads to still more volume.
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