Introduction
The past three decades have been a remarkable period for innovation. This is no less true, and probably truer, for financial innovation. No prior period of equal length has ever witnessed anything that even comes close. This innovation has included amazing advances in financial theory, computational capability, new product design, new trading processes, new markets, and new applications. In fact, each of these innovations has supported and reinforced the others. In the early 1990s, practitioners and academics alike began to recognize that this spate of innovation was not just a passing fad. Rather, something fundamental had changed. Indeed, something had, and the new profession known as financial engineering emerged. These think-out-of-the box, often technologically and/or quantitatively sophisticated, individuals are the drivers behind the new finance.
All periods of innovation are traumatic. The old, only grudgingly, makes way for the new. Adapting to a new environment takes effort, and not all will survive. For example, many floor traders on stock, futures, and options exchanges fought tooth and nail to prevent the introduction of electronic trading platforms. But, in the end, the new platforms won out. Why? Because they are better—they are faster, less error prone, and they lead to tighter bid-ask spreads, which means lower transaction costs for investors. ...
