Elsevier UK Jobcode:RTF Chapter:CH01-H8304 30-3-2007 5:20p.m. Page:7 Trimsize:165×234MM
Fonts used:Ocean Sans & Sabon Margins:Top:42pt Gutter:54pt Font Size:10/12 Text Width:30p6 Depth:47 Lines
Innovation in finance 7
The quantitative reasoning of mathematicians, physicists and engineers blends with
the qualitative thinking of economists and other professionals, and
This cross-fertilization of know-how and action models opened new horizons in
analysis, which has now been institutionalized; but in the 1950s it was a ‘first’.
As long as their products and services were plain vanilla, banks did not feel the
urge for instituting and financing think-tanks. But in the early 1970s, with the end of
the Bretton Woods agreements, which led to flexible currency exchange rates, things
started to change. Risk management requirements (Chapter 2), derivative financial
instruments (Chapter 3) and a marketplace more competitive than ever promote the
concept of a laboratory of ideas.
Over the space of a few years, the foreign exchange markets became vibrant
requiring brains and tools able to prognosticate. Also in the early 1970s, the Black-
Scholes algorithms were made feasible to price options, with a pricing mechanism
which became generally accepted and the options market took off. As globalization
progressed trading in forex and in options became favored products of financial
institutions – but exposure, too, mounted.
The deregulation of banking in the late 1970s/early 1980s intensified competition
among banks, bringing attention to innovation as a way of keeping the upper
It also promoted a strong sense of institutional pragmatism, which accentuated the
need for analysts, as a way of studying the ever-growing financial forces.
The first think-tank in the banking industry was the Advanced Systems Group
(ASG), of Morgan Stanley, instituted in the late 1980s. Others followed. ASG was
a small R&D laboratory compared with laboratories in the manufacturing industry,
but a big one in finance. Its produce was innovative derivative instruments, with an
income of $50 million per year. The RAND of the banking industry was born.
1.3 Challenging the obvious
This section includes three short case studies which superficially look like being miles
apart. Yet, as the careful reader will find, they are well connected because they share,
and address, the same notions which confront any physicist, banker, strategic planner
or decision maker worth his or her salt:
Challenging the ‘obvious’, and
Using imagination and guts in overtaking the incumbent – whether this is a theory,
concept, or company.
Challenging what may look ‘obvious’ is so fundamental because a basic principle
in science is to assume nothing. The possibility is always present that even the most
famous theory will be proved wrong (see Chapter 6). Acceptance without questioning
is yesmanship – and, therefore, anathema to the research spirit.