Non-diversifiable Risk and Endogenous Innovation

I propose a theoretical framework to study jointly the process of innovation and asset pricing properties of investment in innovation. The model emphasizes the disruptive nature of new technologies. When risk-sharing is limited, this feature gives rise to hedging motives against potential disruption. Investors' hedging activity increases the pace of innovation and generates observed empirically volatile fluctuations of the volume of investments in innovation and risk premium on such investments. The model explains a set of stylized facts that link innovation activity and risk, and reconciles empirical properties and puzzles of aggregate flows and performance in venture capital