The Risk of Schumpeterian Competition

While previous work has focused on the rewards of creative destruction, this paper explores how Schumpeterian competition affects risk. We analyze a game in a Lucas endowment economy in which non-cooperative agents compete for the rents of a consumption stream and bear the risk imposed by creative destruction. Compared to first best, the quest for oligopoly rents leads to over-investment in uncertain projects, which magnifies both the volatility of future consumption and the uncertainty about the expected growth rate of the economy. Within the context of our model, this results in spikes in the price- dividend ratio. If competition for rents is sufficiently intense, the elevated price-dividend ratio predicts negative future expected excess returns, which is consistent with the patterns typically observed during periods of marked technological change.