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Market-Based Solutions to Vital Economic Issues


Kenan Institute 2023 Grand Challenge: Workforce Disrupted
Market-Based Solutions to Vital Economic Issues
Mar 16, 2020

Production Networks and Stock Returns: The Role of Vertical Creative Destruction


We examine empirically and theoretically the relation between firms’ risk and distance to consumers in a production network. We document two novel facts: firms farther away from consumers have higher risk premiums and higher exposure to aggregate productivity. We quantitatively explain these findings using a general equilibrium model featuring a multilayer production process. The economic force is “vertical creative destruction,” that is, positive productivity shocks to suppliers devalue customers’ assets-in-place, thereby lowering the cyclicality of downstream firms’ values. We show that vertical creative destruction varies with competition and firm characteristics and generates sizable cross-sectional differences in risk premiums.

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