Does financial innovation lead to technological innovation? Evidence from foreign exchange derivatives

We investigate whether financial innovation, specifically the use of foreign exchange (FX) derivative products, spurs firms’ technological innovation, measured with patent-based metrics. Using a quasi-exogenous shock that reduces the cost of using FX derivatives and varying FX equity exposure of firms, we find that increased utilization of FX derivatives results in higher patent production. The primary mechanism driving this relationship is the reduction in financial constraints and enhanced risk management. The effect is especially pronounced for firms facing difficulties in raising equity capital. Our results indicate that the use of FX derivatives boosts innovative output by improving firms’ ability to raise equity capital, thereby increasing R&D investment, rather than by increasing risk-taking.