Production Networks and Stock Returns: The Role of Vertical Creative Destruction
86 Pages Posted: 6 Jun 2017 Last revised: 5 Aug 2018
Date Written: August 1, 2018
We study the relation between firms' risk and their upstreamness in a production network. Empirically, firms' average stock returns and productivity exposures increase monotonically with their upstreamness. We quantitatively explain these novel facts using a multi-layer general equilibrium model. These patterns arise 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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