Title: A taxonomy of the 'dark side' of financial innovation: the cases of high frequency trading and exchange traded funds

Authors: Ivan Diaz-Rainey; Gbenga Ibikunle

Addresses: Department of Accountancy and Finance, School of Business, University of Otago, P.O. Box 56, Dunedin, 9054, New Zealand. ' Environmental and Energy Finance Group, Norwich Business School, University of East Anglia, Norwich, NR4 7TJ, UK

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 by categorising the negative effects of financial innovation as: 1) predatory schemes; 2) abuse of financial innovation; 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.

Keywords: financial innovation; financial regulation; financial risk; high frequency trading; HFT; exchange traded funds; EFTs; systemic risk; EU policy; flash crash; European Union; predatory schemes; unintended consequences; financial crisis; credit crunch.

DOI: 10.1504/IJEIM.2012.050443

International Journal of Entrepreneurship and Innovation Management, 2012 Vol.16 No.1/2, pp.51 - 72

Published online: 31 Jul 2014 *

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