Production Networks and Stock Returns: The Role of Creative Destruction
52 Pages Posted: 6 Jun 2017 Last revised: 10 Nov 2017
Date Written: November 5, 2017
We establish a novel return spread based on the distance between firms and final consumers in a production network. Firms with the longest distance to consumers earn an excess monthly return of 105 basis points relative to final goods producers. We explain this spread quantitatively using a general equilibrium model with multiple layers of production. The driving force behind the spread is creative destruction, which reduces firms’ exposure to productivity shocks. The spread is smaller for firms that belong to supply chains with lower competition. Overall, our results demonstrate a novel effect of creative destruction on firms’ cost of capital.
Keywords: production networks, stock returns, creative destruction, monopolistic competition, technological innovations
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