DP12617 Government Debt and the Returns to Innovation

Author(s):	Mariano Massimiliano Croce, Thiên Tung Nguyen, Steve Raymond, Lukas Schmid
Publication Date:	January 2018
Keyword(s):	Cross Section of Stock Returns, Fiscal Uncertainty, Government Debt, Government Debt, growth, predictability, R&D
JEL(s):
Programme Areas:	Financial Economics
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=12617

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.