Production Networks and Stock Returns: The Role of Vertical Creative Destruction
Review of Financial Studies (Forthcoming)
90 Pages Posted: 6 Jun 2017 Last revised: 2 Feb 2020
Date Written: January 19, 2020
We examine empirically and theoretically the relation between firms' risk and their distance to consumers in a production network. We document two novel facts: firms that are further away from consumers have higher risk premia and higher exposures to aggregate productivity. We quantitatively explain these findings using a general equilibrium model featuring a multi-layer production process. The economic force is vertical creative destruction" --- positive productivity shocks to suppliers devalue customers' assets-in-place, which lowers the cyclicality of downstream firms' values. We show that vertical creative destruction varies with competition and firm characteristics, and generates sizable cross-sectional differences in risk premia.
Keywords: production networks, stock returns, creative destruction, monopolistic competition, technological innovations
JEL Classification: G10, G12
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