A Taxonomy of the ‘Dark Side’ of Financial Innovation: The Cases of High Frequency Trading and Exchange Traded Funds

International Journal of Entrepreneurship and Innovation Management (IJEIM), Forthcoming

25 Pages Posted: 20 Dec 2011 Last revised: 17 Jan 2016

See all articles by Ivan Diaz-Rainey

Ivan Diaz-Rainey

CEFGroup & Department of Accountancy and Finance, University of Otago

Gbenga Ibikunle

University of Edinburgh; European Capital Markets Cooperative Research Centre

Date Written: December 19, 2011

Abstract

This paper develops a taxonomy of the ‘dark side’ of financial innovation and applies it to two recent high-profile financial innovations; exchange traded funds (ETFs) and high frequency trading (HFT). The first half of the paper develops the taxonomy through a review of related literature. Accordingly, the negative effects of financial innovation are categorised as (1) predatory schemes (2) abuse of financial innovation and (3) unintended consequences of financial innovation. The second half of the paper applies the taxonomy to ETFs and HFT, thus allowing for a better understanding of the risks posed by ETFs and HFT. We explore these risks with examples and in the context of current efforts to reform financial regulation following the 2007-2008 ‘credit crunch’. In the latter case we draw on a G20 survey that explored the capabilities of regulators to mitigate the negative effects of financial innovation. Overall, we conclude that even though both innovations offer potential societal benefits of greater market efficiency (HFT) and more effective diversification (ETF), both pose considerable and contrasting risks. These risks can be mitigated by strengthening regulatory capabilities with respect to financial innovation and by firm level corporate governance improvements.

Keywords: Financial Innovation, Financial Regulation, Financial Risk, High Frequency Trading, Exchange Traded Funds, Systemic risk, EU Policy, Flash Crash

Suggested Citation

Diaz-Rainey, Ivan and Ibikunle, Gbenga, A Taxonomy of the ‘Dark Side’ of Financial Innovation: The Cases of High Frequency Trading and Exchange Traded Funds (December 19, 2011). International Journal of Entrepreneurship and Innovation Management (IJEIM), Forthcoming, Available at SSRN: https://ssrn.com/abstract=1974914 or http://dx.doi.org/10.2139/ssrn.1974914

Ivan Diaz-Rainey (Contact Author)

CEFGroup & Department of Accountancy and Finance, University of Otago ( email )

Dunedin
New Zealand

Gbenga Ibikunle

University of Edinburgh ( email )

Old College
South Bridge
Edinburgh, Scotland EH8 9JY
United Kingdom

European Capital Markets Cooperative Research Centre ( email )

Viale Pidaro 42
Pescara, 65121
Italy

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