Journal of Evolutionary Economics

, Volume 28, Issue 2, pp 287–303 | Cite as

Innovation and stock market performance: A model with ambiguity-averse agents

  • Daniela GriecoEmail author
Regular Article


Empirical evidence on stock prices shows that firms investing successfully in radical innovation experience higher stock returns. This paper provides a model that sheds light on the relationship between the degree of firm innovativeness and stock returns, the movements of which capture expectations on firm’s profitability and growth. The model is grounding on Neo-Schumpeterian growth models and relies on the crucial assumption of radical innovation, characterized by “ambiguity” or Knightian uncertainty: due to its uniqueness and originality, no distribution of probability can be reasonably associated with radical innovation success or failure. Different preferences (α-maxmin, Choquet) are here compared. Results show that the assumption of ambiguity-aversion is crucial in determining higher returns in the presence of radical innovation and that the specific definition of expected utility shapes the extent of the returns. This result holds also in the case of endogenous innovation; risk attitude plays no role.


ambiguity radical innovation stock returns stochastic discount factor uncertainty 

JEL Classification

D81 G12 O31 


Compliance with ethical standards

Conflict of interest

The authors declares that she has no conflict of interest.


  1. Adams ME, Day GS, Dougherty D (1998) Enhancing new product development performance: An organizational learning perspective. J Prod Innov Manag 15(5):403–422CrossRefGoogle Scholar
  2. Aizenman J (1997) Investment in new activities and the welfare cost of uncertainty. J Dev Econ 52:259–277CrossRefGoogle Scholar
  3. Athanassoglou S, Bosetti V, DeMaere G (2012) Ambiguous aggregation of expert opinions: The case of optimal R&D investment. FEEM Working Paper n. 004Google Scholar
  4. Battaggion MR, Grieco D (2009) Radical Innovation and R&D Competition. Rivista italiana degli economisti 14(2):345–360Google Scholar
  5. Beck M, Lopes Bento C, Schenker-Wicki A (2016) Radical or incremental: Where does R&D policy hit? Res Policy (in press)Google Scholar
  6. Butler JV, Guiso L, Jappelli T (2011) The role of intuition and reasoning in driving aversion to risk and ambiguity. CEPR Discussion Paper No. DP8334. Available at SSRN:
  7. Camerer C, Weber M (1992) Recent developments in modeling preferences: Uncertainty and ambiguity. J Risk Uncertain 5(4):325–370CrossRefGoogle Scholar
  8. Campbell JY (2000) Asset pricing at the millennium. J Financ 55:1515–1567CrossRefGoogle Scholar
  9. Campbell JY, Shiller RJ (1984) A Simple Account of the Behavior of Long-Term Interest Rates. Am Econ Rev 74(2):44–48Google Scholar
  10. Campbell JY, Shiller RJ (1988) Stock prices, earnings, and expected dividends. J Financ 43(3):661–676CrossRefGoogle Scholar
  11. Campbell JY, Lettau M, Malkiel BG, Yexiao X (2000) Have individual stocks become more volatile? An empirical exploration of idiosyncratic risk. J Financ 56:1–43CrossRefGoogle Scholar
  12. Chesson HW, Viscusi WK (2003) Commonalities in time and ambiguity aversion for long-term risks. Theor Decis 54(1):57–71CrossRefGoogle Scholar
  13. Choquet G (1955) Theory of capacities. Annual Institute Fourier (Grenoble) 5:131–295CrossRefGoogle Scholar
  14. Cooke RM (1991) Experts in uncertainty: opinion and subjective probability in science. New York: Oxford University PressGoogle Scholar
  15. Dewar RD, Dutton JE (1986) The adoption of radical and incremental changes: An empirical analysis. Manag Sci 32(11):1422–1433CrossRefGoogle Scholar
  16. Dixit AK, Stiglitz JE (1977) Monopolistic competition and optimum product diversity. Am Econ Rev 67(3):297–308Google Scholar
  17. Dow J, da Costa Werlang SR (1992) Excess volatility of stock prices and Knightian uncertainty. Eur Econ Rev 36(2):631–638CrossRefGoogle Scholar
  18. Dow J, Werlang SRC (1992) Uncertainty aversion, risk aversion, and the optimal choice of portfolio. Econometrica 60:197–204CrossRefGoogle Scholar
  19. Einhorn HJ, Hogarth RM (1982) Prediction, diagnosis, and causal thinking in forecasting. J Forecast 1(1):23–36CrossRefGoogle Scholar
  20. Ellsberg D (1961) Risk, ambiguity, and the Savage axioms. Q J Econ 75(4):643–669CrossRefGoogle Scholar
  21. Epstein LG, Schneider M (2010) Ambiguity and asset markets. Annu Rev Financ Econ 2(1):315–346CrossRefGoogle Scholar
  22. Epstein LG, Wang T (1994) Intertemporal asset pricing under Knightian uncertainty. Econometrica 62(2):283–322Google Scholar
  23. Ethier WJ (1982) National and international returns to scale in the modern theory of international trade. Am Econ Rev 72(3):389–405Google Scholar
  24. Fleming L (2001) Recombinant uncertainty in technological search. Manag Sci 47(1):117–132CrossRefGoogle Scholar
  25. Gambardella A (1995) Science and Innovation: the US Pharmaceutical Industry During the 1980s. Cambridge University Press, CambridgeCrossRefGoogle Scholar
  26. Garcia R, Calantone R (2002) A critical look at technological innovation typology and innovativeness terminology: a literature review. J Prod Innov Manag 19(2):110–132CrossRefGoogle Scholar
  27. Garthwaite PH, Kadane JB, O'Hagan A (2005) Statistical methods for eliciting probability distributions. J Am Stat Assoc 100(470):680–701CrossRefGoogle Scholar
  28. Ghirardato P, Marinacci M (2001) Risk, ambiguity, and the separation of utility and beliefs. Math Oper Res 26:864–890CrossRefGoogle Scholar
  29. Ghirardato P, Marinacci M (2002) Ambiguity made precise: A comparative foundation. J Econ Theory 102(2):251–289CrossRefGoogle Scholar
  30. Ghirardato P, Maccheroni F, Marinacci M (2004) Differentiating ambiguity and ambiguity attitude. J Econ Theory 118:133–173CrossRefGoogle Scholar
  31. Gilboa I (ed) (2004) Uncertainty in Economic Theory: Essays in Honor of David Schmeidler’s 65th Birthday. Routledge, LondonGoogle Scholar
  32. Gilboa I, Marinacci M (2011) Ambiguity and the Bayesian paradigm. Working Papers 379, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi UniversityGoogle Scholar
  33. Gilboa I, Schmeidler D (1989) Maxmin expected utility with non-unique prior. J Math Econ 18(2):141–153CrossRefGoogle Scholar
  34. Grossman GM, Helpman E (1991) Quality ladders in the theory of growth. Rev Econ Stud 58(1):43–61CrossRefGoogle Scholar
  35. Guiso L, Sapienza P, Zingales L (2008) Trusting the stock market. the. J Financ 63(6):2557–2600CrossRefGoogle Scholar
  36. Henderson R (1993) Underinvestment and incompetence as responses to radical innovation: Evidence from the photolithographic alignment equipment industry. RAND J Econ 24:248–270CrossRefGoogle Scholar
  37. Henderson RM, Clark KB (1990) Architectural innovation: The reconfiguration of existing product technologies and the failure of established firms. Adm Sci Q 35:9–32CrossRefGoogle Scholar
  38. Jones LE, Manuelli R (1990) A convex model of equilibrium growth. NBER Working Papers 3241, National Bureau of Economic ResearchGoogle Scholar
  39. Jovanovic B, Greenwood J (1999) The IT revolution and the stock market. NBER Working Papers 6931, National Bureau of Economic ResearchGoogle Scholar
  40. Jovanovic B, MacDonald G (1994) The life-cycle of a competitive industry. NBER Working Papers 4441, National Bureau of Economic ResearchGoogle Scholar
  41. Kaluzny A, Veney JE, Gentry JT (1972) Innovation of health services: A comparative study of hospitals and health departments. Q Health Soc 52(1):51–82Google Scholar
  42. Keppo I, van der Zwaan B (2012) The impact of uncertainty in climate targets and CO2 storage availability on long-term emissions abatement. Environ Model Assess 17(1–2):177–191CrossRefGoogle Scholar
  43. Klibanoff P, Marinacci M, Mukerji S (2005) A smooth model of decision making under ambiguity. Econometrica 73(6):1849–1892CrossRefGoogle Scholar
  44. Klibanoff P, Marinacci M, Mukerji S (2009) Recursive smooth ambiguity preferences. J Econ Theory 144(3):930–976CrossRefGoogle Scholar
  45. Knight FH (1921) Risk, Uncertainty and Profit. Harper and Row, New YorkGoogle Scholar
  46. Knox TA (2003) Foundations for learning how to invest when returns are uncertain. Working paper, University of Chicago Graduate School of BusinessGoogle Scholar
  47. Leifer R, Colarelli O'Connor G, Rice M (2001) Implementing radical innovation in mature firms: The role of hubs. Acad Manag Rev 3:102–113Google Scholar
  48. Lucas RE (1988) On the mechanisms of economic development. J Monet Econ 22(1):3–42CrossRefGoogle Scholar
  49. Machina MJ (1982) Expected utility analysis without the Independence Axiom. Econometrica 50:277–323CrossRefGoogle Scholar
  50. Manski CF (2004) Measuring expectations. Econometrica 72(5):1329–1376CrossRefGoogle Scholar
  51. Mazzucato M (2003) Risk, variety and volatility: Innovation, growth and stock prices in old and new industries. J Evol Econ 13(5):491–512CrossRefGoogle Scholar
  52. Mazzucato M (2006) Innovation and stock prices: A review of some recent work. Revue de L’Observatoire Francais de Conjonctures Economiques, SpeciaGoogle Scholar
  53. Mazzucato M, Semmler W (1999) Stock market volatility and market share instability during the US auto industry life-cycle. J Evol Econ 9(1):67–96CrossRefGoogle Scholar
  54. Mazzucato M, Tancioni M (2005) Innovation and Idiosyncratic Risk. Computing in Economics and Finance, 81, Society for Computational EconomicsGoogle Scholar
  55. Mazzucato M, Tancioni M (2008) Innovation and idiosyncratic risk: an industry-and firm-level analysis. Ind Corp Chang 17(4): 779–811CrossRefGoogle Scholar
  56. Mazzucato M, Tancioni M (2012) R&D, patents and stock return volatility. J Evol Econ 22:811–832CrossRefGoogle Scholar
  57. Nord WR, Tucker S (1987) Implementing Routine and Radical Innovations. Lexington Books, LexingtonGoogle Scholar
  58. O'Connor GC (1998) Market learning and radical innovation: A cross case comparison of eight radical innovation projects. J Prod Innov Manag 15(2):151–166CrossRefGoogle Scholar
  59. O'Hagan A, Buck CE, Daneshkhah A, Eiser JR, Garthwaite PH, Jenkinson DJ, Rakow T (2006) Uncertain Judgements: Eliciting Experts' Probabilities. Wiley, New YorkCrossRefGoogle Scholar
  60. Pakes A (1982) On the asymptotic bias of the Wald-type estimators of a straight line when both variables are subject to error. Int Econ Rev 23:491–497CrossRefGoogle Scholar
  61. Pastor L, Veronesi P (2003) Stock valuation and learning about profitability. J Financ 58:1749–1790CrossRefGoogle Scholar
  62. Pastor L, Veronesi P (2006) Was there a Nasdaq bubble in the late 1990s? J Financ Econ 81(1):61–100CrossRefGoogle Scholar
  63. Rebelo S (1991) Long-run policy analysis and long-run growth. J Polit Econ 99(3):500–521CrossRefGoogle Scholar
  64. Rivera-Batiz LA, Romer PM (1991) International trade with endogenous technological change. Eur Econ Rev 35(4):971–1001CrossRefGoogle Scholar
  65. Romer PM (1986) Increasing returns and long-run growth. J Polit Econ 94:1002–1038CrossRefGoogle Scholar
  66. Romer PM (1987) Growth based on increasing returns due to specialization. Am Econ Rev 7(2):56–72Google Scholar
  67. Romer PM (1990) Endogenous technological change. J Polit Econ 98(5):71–102CrossRefGoogle Scholar
  68. Romer P (1994) New goods, old theory, and the welfare costs of trade restrictions. J Dev Econ 43(1):5–38CrossRefGoogle Scholar
  69. Sarin RK, Weber M (1993) Effects of ambiguity in market experiments. Manag Sci 39:602–615CrossRefGoogle Scholar
  70. Savage LJ (1954) The Foundations of Statistics. Wiley, New YorkGoogle Scholar
  71. Schmeidler D (1989) Subjective probability and expected utility without additivity. Econometrica 57(3):571–583CrossRefGoogle Scholar
  72. Shiller R (2000) Irrational Exuberance. Princeton University Press, PrincetonGoogle Scholar
  73. Siddiqui AS, Marnay C, Wiser RH (2007) Real options valuation of US federal renewable energy research, development, demonstration, and deployment. Energ Policy 35(1):265–279CrossRefGoogle Scholar
  74. Sorescu A, Chandy R, Prabhu J (2003) Sources and financial consequences of radical innovation. J Mark 66:82–102CrossRefGoogle Scholar
  75. Trautmann ST, Vieider FM, Wakker PP (2008) Causes of ambiguity aversion: Known versus unknown preferences. J Risk Uncertain 36:225–243CrossRefGoogle Scholar
  76. Veronesi P (2000) How does information quality affect stock returns? J Financ 55(2):807–837CrossRefGoogle Scholar

Copyright information

© Springer-Verlag GmbH Germany 2017

Authors and Affiliations

  1. 1.Department of EconomicsBocconi UniversityMilanItaly

Personalised recommendations