Innovation and stock market performance: A model with ambiguity-averse agents (original) (raw)

Abstract

Empirical evidence on stock prices shows that firms investing successfully in radical innovation experience higher stock returns. This paper provides a model that sheds light on the relationship between the degree of firm innovativeness and stock returns, whose movements capture expectations on firm’s profitability and growth. The model grounds on the Neo-Schumpeterian growth models setup and relies on the crucial assumption of radical innovation characterized by “ambiguity” or Knightian uncertainty: due to its uniqueness and originality, no distribution of probability can be reasonably associated to radical innovation’ success or failure. Extreme (maxmin preferences) and smoother ambiguity aversion (alpha-maxmin, Choquet) are here compared. Results show that the assumption of ambiguity-aversion is critical in determining higher returns in presence of radical innovation and the specific definition of expected utility shapes the extent of the returns. Risk attitude plays no role.

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