Production Networks and Stock Returns: The Role of Creative Destruction
We establish a novel return spread based on the distance between firms and final consumers in a production network. An investment strategy that longs firms with the longest distance and shorts firms with the shortest distance to consumers earns a monthly return of 105 basis points. We explain this spread quantitatively using a general equilibrium model with multiple layers of production. The driving force behind the spread is creative destruction. The spread is smaller for firms that belong to supply chains with lower competition. Overall, our results provide empirical and theoretical support for creative destruction based on financial markets.
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