Prof. Jayanth R. Varma's Financial Markets Blog

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Prof. Jayanth R. Varma's Financial Markets Blog, A Blog on Financial Markets and Their Regulation

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Tue, 02 Jan 2007

Alphabet Soup is not Innovation

Gillian Tett, the capital markets editor of the Financial Times writes (“Let us pass on the alphabet soup, SVP”, Financial Times, December 29, 2006) that bankers trained in science and mathematics are creating innovative debt instruments but giving them unimaginative names with unwieldy acronyms – the alphabet soup.

He talks about “the broader acceleration of the global financial innovation cycle” and says “banks are responding by inventing products at such a furious pace, they barely have time to think up names.” By contrast, he argues that “A couple of decades ago, when new financial products hit the markets, banks gave them names. A host of new words crept into the investment bible over the years, such as options, swaps or puts”.

I am unable to agree with this view. Much of the alphabet soup today does not represent really new products. Rather it consists of simple adaptations to the credit market of ideas and instruments well known in equity and other markets. Compared to true innovations like cash settled index futures, the credit market innovations that we are seeing are minor modifications and adaptations of well known dynamic portfolio strategies.

For decades, credit has been the preserve of the banking system. Today, as credit breaks out of that prison and moves into the hands of people accustomed to the joys and pleasures of vibrant financial markets, we are seeing a lot of changes. Even the simple idea of trading a portfolio of credits rather than a single credit appears revolutionary though this is what equity traders have been doing for decades now. However, all this is catch up and not innovation.

Posted at 12:22 on Tue, 02 Jan 2007     View/Post Comments (2)     permanent link