Financial Innovation and the Management and Regulation of Financial Institutions

by Robert C. Merton of Harvard University

June 1995

Abstract: New security designs, improvements in computer and telecommunications technology and advances in the theory of finance have led to revolutionary changes in the structure of financial markets and institutions. This paper provides a functional perspective on the dynamics of institutional change and uses a series of examples to illustrate the breadth and depth of institutional change that is likely to occur. These examples emphasize the role of hedging versus equity capital in managing risk, the need for risk accounting and changes in methods for implementing both regulatory and stabilization public policy.

JEL Classification: G2, G3.

Keywords: Financial innovation, Banking, Finance.

Published in: Journal of Banking & Finance, Vol. 19, No. 3-4, (June 1995), pp. 461-481.

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