Innovation Under Ambiguity and Risk

We view innovation investments as real options and explore the implications of risk (volatility) as well as a newly defined outcome independent measure of ambiguity (Knightian uncertainty) for innovation decisions. The empirical analysis uses stock returns to compute an implementable measure of ambiguity. We also control for risk and other determinants of innovation. We find a consistently significant negative effect of ambiguity on R&D, patents, and citations, as predicted. The effect of risk on R&D is positive and significant, but the corresponding effect on patents and citations is negative and significant. Ambiguity matters more for high-tech firms, consistent with intuition.