Why and when financial instruments are created: a learning story

The relationship between financial development and growth has been the subject of intense scrutiny. Economists debate whether finance causes growth [Hicks (1969), Schumpeter (1934)], or whether it is growth that triggers the development of financial markets [Robinson (1952)]. This paper proposes the view that financial development arises as a response to the contractual needs of emerging technologies. Exogenous technological progress generates a derived demand for new financial instruments that facilitate the adoption of the new technologies; those instruments may help investors share risk or overcome private information issues, for example.