Schumpeterian Competition in a Lucas Economy

Abstract

We model a rent-seeking game where agents experiment with a new technology and compete for claims to a consumption stream. We characterize how creative destruction affects risk, wealth, and asset prices. Competition not only imposes excessive disruption risk on existing assets and higher technological uncertainty, it also increases the wealth duration (the weighted-average maturity of wealth). Because of hedging motives, a complementarity between wealth duration and technological uncertainty decreases systematic risk. If competition is sufficiently intense, a negative risk premium may arise. The model generates price paths consistent with boom-bust patterns and transient episodes of negative expected excess returns. We show that Schumpeterian competition may worsen income inequality.

Keywords: Schumpeterian Competition; Experimentation; Tullock contests; Creative Destruction; Return Predictability; Income Inequality.

JEL Classification: G11, G12, G14, L13, O33.