Production Networks and Stock Returns: The Role of Vertical Creative Destruction
78 Pages Posted: 6 Jun 2017 Last revised: 6 May 2018
Date Written: April 28, 2018
We study the relation between firms' risk and their upstreamness in a production network. Empirically, the monthly return spread between upstream and downstream firms is 105 bps. We quantitatively explain this novel spread using a multi-layer general equilibrium model. The spread arises from vertical creative destruction -- innovations by suppliers devalue customers’ assets-in-place. We confirm several model predictions, and document additional new facts consistent with vertical creative destruction: a diminished value premium among downstream firms and a negative relation between downstream firms’ returns and their suppliers’ competitiveness. Overall, vertical creative destruction has a sizable effect on cross-sectional risk premia.
Keywords: production networks, stock returns, creative destruction, monopolistic competition, technological innovations
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