Heterogeneous Innovation, Firm Creation and Destruction, and Asset Prices

We study the implications of creative destruction on asset prices. We develop a general equilibrium model of endogenous firm creation and destruction in which "incremental" innovation by incumbents and "radical" innovation by entrants drive productivity improvements. Firms' incentives to innovate generate time-varying economic growth and countercyclical economic uncertainty. The model matches key properties of consumption and asset prices, as well as novel facts on the process of creative destruction in the United States obtained using a sample of patents from 1975-2013. We show that the interplay between incumbents and entrants is an important determinant of risks priced in the financial markets.