Working paper

The dynamics of innovation and risk

Bruno Biais, Jean-Charles Rochet, and Paul Woolley

Abstract

We study the dynamics of an innovative industry when agents learn about the likelihood of negative shocks. Managers can exert risk-prevention effort to mitigate the consequences of shocks. If no shock occurs, confidence improves, attracting managers to the innovative sector. But, when condence becomes high, inefficient managers exerting low risk-prevention effort also enter. This stimulates growth, while reducing risk-prevention. The longer the boom, the larger the losses if a shock occurs. While these dynamics arise in the first-best, asymmetric information generates excessive entry of inefficient managers, earning informational rents, inflating the innovative sector and increasing its vulnerability.

Replaced by

Bruno Biais, Jean-Charles Rochet, and Paul Woolley, The dynamics of innovation and risk, The Review of Financial Studies, vol. 28, n. 5, 2015, pp. 1353–1380.

See also

Published in

TSE Working Paper, n. 13-448, October 2013