Innovation, industry equilibrium, and discount rates

Abstract

maria cecilia bustamante, francesca zucchi working paper series innovation, industry equilibrium, and discount rates no 2835 disclaimer: this paper should not be reported as representing the views of the european central bank (ecb). the views expressed are those of the authors and do not necessarily reflect those of the ecb. abstract we develop a model to examine how discount rates affect the nature and composition of innovation within an industry. challenging conventional wisdom, we show that higher discount rates do not discourage firm innovation when accounting for the industry equilibrium. higher discount rates deter fresh entry—effectively acting as entry barriers—but encourage innovation through the intensive margin, which can lead to a higher industry innovation rate on net. simultaneously, high discount rates foster explorative over exploitative innovation. the model rationalizes observed patterns of innovation cyclicality, and predicts that lower entry in downturns hedges innovating incumbents against higher discount rates. keywords: vertical and horizontal innovation, creative destruction, time-varying discount rates, risk premia. jel classification numbers: g31; g12; o31 ecb working paper series no 28351 non-technical summary since schumpeter (1939), scholars have argued that innovation is key to understand the real economy. in recent years, the study of the determinants of corporate innovation has become particularly relevant, as firms’ investment in research and …

Source: pdf_first_chars