Production Networks and Stock Returns: The Role of Vertical Creative Destruction

78 Pages Posted: 6 Jun 2017 Last revised: 6 May 2018

Michael Gofman

Simon School of Business

Gill Segal

University of North Carolina (UNC) at Chapel Hill - Finance Area

Youchang Wu

University of Oregon - Lundquist College of Business

Date Written: April 28, 2018

Abstract

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

Suggested Citation

Gofman, Michael and Segal, Gill and Wu, Youchang, Production Networks and Stock Returns: The Role of Vertical Creative Destruction (April 28, 2018). Available at SSRN: https://ssrn.com/abstract=2981447 or http://dx.doi.org/10.2139/ssrn.2981447

Michael Gofman (Contact Author)

Simon School of Business ( email )

Rochester, NY 14627
United States

HOME PAGE: http://gofman.info

Gill Segal

University of North Carolina (UNC) at Chapel Hill - Finance Area ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

Youchang Wu

University of Oregon - Lundquist College of Business ( email )

1280 University of Oregon
Eugene, OR 97403
United States

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