Asset pricing implications of technological innovation

Abstract

Technological innovation is the engine of economic growth and social-welfare improvement. Although technological innovation is extensively studied in the literature of economics, its asset pricing implications in finance is under-explored. In my thesis, I examine one overlooked but important category of innovation, which is medical innovation, in Chapter Two. In Chapter Three, I document one potential dark side of the current innovation system, which is named "patent thicket". Medical innovation promotes health, facilitates human capital accumulation, and influences asset prices. Using a manually collected dataset on drug approvals to identify medical innovation in Chapter Two, I find that, on the aggregate level, a higher medical innovation shock predicts higher labor productivity growth and TFP growth in the next five years. Consistent with a production-based model, firms with higher stock-return loadings on medical innovation shocks employ more human capital, are more volatile in future performance, and have higher future stock returns. Further tests confirm that medical shock is a systematic risk, one whose price is about 5% per year. Overall, my findings in Chapter Two collectively highlight medical innovation in asset pricing through the channel of human capital. When firms innovate on the basis of prior patents dispersedly owned by different patent assignees, the fragmented patent ownership results in patent thickets that adversely affact the commercialization of these firms' inventions. In Chapter Three, two coauthors and I develop a real option model that suggests a negative effect of patent thickets on systematic risk exposure and expected stock returns due to increases in commercialization costs, delays in options exercising, and decreases in future stochastic cash flows. Our empirical analyses based on U.S. patent litigations data, new product announcements data, and public firms' patents and financial data support these model implications.