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Market-Based Solutions to Vital Economic Issues


Market-Based Solutions to Vital Economic Issues
Sep 19, 2017

Government Debt and the Returns to Innovation


Elevated levels of government debt raise concerns about their effects on long-term growth prospects. Using the cross section of US stock returns, we show that (i) high-R&D firms are more exposed to government debt and pay higher expected returns than low-R&D firms; and (ii) higher levels of the debt-to-GDP ratio predict higher risk premia for high-R&D firms. Furthermore, rises in the cost of capital for innovation-intensive firms predict declines in subsequent productivity and economic growth. We propose a production-based asset pricing model with endogenous innovation and fiscal policy shocks that can rationalize key aspects of the empirical evidence. Our study highlights a novel and distinct risk channel shaping the link between government debt and future growth.

Note: Research papers posted on SSRN, including any findings, may differ from the final version chosen for publication in academic journals.

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