Chapter 1
The History of Financial Engineering from Inception to Today*
WHAT IS FINANCIAL ENGINEERING?
Financial engineering may be broadly defined as the development and creative application of innovative financial technology. Financial technology includes financial theory, quantitative techniques, financial products, and financial processes. At a microeconomic level, the motivation behind financial engineering is to produce profits for the innovators by finding better ways to address society's needs. At a macroeconomic level financial engineering helps improve the allocation of scarce resources. Allocation of resources is the fundamental objective of any economic system. Indeed, financial engineering epitomizes Joseph Schumpeter's view of capitalism as “creative destruction.” New products replace old products, new theory improves on old theory, and new processes supplant old processes.
Financial engineering borrows heavily and liberally from other disciplines, which helps explain why the field has attracted people from across the scientific spectrum. The key to understanding financial engineering is understanding innovation in all of its dimensions and turning this innovation into practical solutions. While, in some sense, financial engineering has been with us since the innovation of money, financial engineering has not, until quite recently, been recognized as a profession. What has changed, more than anything else, is the pace of innovation.
