The Anatomy of Financial Innovation

This paper examines how innovation in financial products affects firms' ability to raise funds. Firms have issued increasing amounts of security contracts over the last three decades, in terms of total funds raised and in the variety of contracts offered. We develop a model of the allocation of financial products among firms, which allows us to decompose the amount of funds raised through securities into various margins, including the quality of the financial products issued. To validate this model, we construct a data set that captures the entry, novelty, and issuance of financial products by non-financial corporations in the US. We find that changes in the quality of products explain the majority of variation in funds raised. Firms that most increased the amount of securities issued also tended to offer the broadest variety of financial products.