Lukas Schmid

Innovation, Growth, and Asset Prices

We examine the asset pricing implications of a production economy whose long-term growth prospects are endogenously determined by innovation and R&D. In equilibrium, Rh&D endogenously drives a small, persistent component in productivity which generates long-run uncertainty about economic growth. With recursive preferences, households fear that persistent downturns in economic growth are accompanied by low asset valuations and command high risk premia in asset markets. Empirically, we find substantial evidence for innovation-driven low-frequency movements in aggregate growth rates and asset market valuations. In short, equilibrium growth is risky.

Dynamic Corporate Liquidiy

When external finance is costly, liquid funds provide corporations with instruments to absorb and react to shocks. Making optimal use of liquid funds means transferring them to times and states where they are most valuable. We examine the determinants of corporate liquidity management in a dynamic model where stochastic investment opportunities and cash shortfalls provide liquidity needs. Firms can transfer liquidity across time using cash and across states drawing on credit lines subject to debt capacity constraints. We generate empirical and quantitative predictions by means of calibration. Small and constrained firms use cash to provide liquidity to fund investment opportunities, while large and unconstrained firms manage their liquidity needs by means of credit lines. In the time series, equity issuances are used to replenish cash balances, and credit lines to fund unanticipated investment opportunities. We find strong support for our predictions in the data. Overall, the model thus provides a quantitatively and empirically successful framework explaining corporate investment, financing and liquidity policies and the joint occurrence of cash, debt and credit lines in the presence of capital market imperfections.

Competition, Markups and Predictable Returns

Imperfect competition is an important channel for time-varying risk premia in asset markets. We build a general equilibrium model with monopolistic competition and endogenous firm entry and exit. Endogenous variation in industry concentration generates countercyclical markups, which amplifies macroeconomic risk. The nonlinear relation between the measure of firms and markups endogenously generates countercyclical macroeconomic volatility. With recursive preferences, the volatility dynamics leads to countercyclical risk premia forecastable with measures of competition. Also, the model produces a U-shaped term structure of equity returns.

Interest Rate Risk Management in Uncertain Times

We revisit evidence of real effects of uncertainty shocks in the context of interest rate uncertainty. We document that adverse movements in interest rate uncertainty predict significant slowdowns in real activity, both at the aggregate and at the firm levels. To understand how firms cope with interest rate uncertainty, we develop a dynamic model of corporate investment, financing, and risk management and test it using a rich data set on corporate swap usage. We find that interest rate uncertainty depresses financially constrained firms’ investments in spite of hedging opportunities, because risk management by means of swaps is effectively risky. Received December 11, 2016; editorial decision January 26, 2018 by Editor Itay Goldstein. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web Site next to the link to the final published paper online.Uncertainty about the future path of interest rates is associated with a significant slowing of future economic activity both at the aggregate and firm level. Using a large data set on firms’ interest rate swap usage, we find that 1) interest rate risk management helps firms attenuate the adverse effects of interest rate uncertainty on investment and 2) there are significant crosssectional differences in swap usage according to asset and financing risk. To interpret these findings, we develop a dynamic model of corporate interest rate risk management in the presence of investment and financing frictions.

Dynamic Corporate Liquidity

In contrast to cash holdings, credit lines give firms financial flexibility by providing liquidity contingent on realized funding needs, but they are often limited by collateral and covenants. We embed this trade-off into an estimated dynamic model of financing and investment. Our model highlights the relevance of drawing down credit lines to fund investment options in an effective way and quantitatively matches well the levels and dynamics of cash, credit lines, and leverage. In the cross-section, modeling credit lines as contingent liquidity provides novel empirical predictions and rationalizes several stylized facts regarding credit line usage, covenant violations, and cash holdings.

A Tax Plan for Endogenous Innovation

In times when elevated government debt raises concerns about dimmer global growth prospects, we ask: How can the government provide incentives for innovation in a fiscally sustainable way? We address this question by examining the Ramsey problem of finding optimal tax and subsidy schemes in a model in which growth is endogenously sustained by risky innovation. We characterize the shadow value of growth and entry in the innovation sector. We find that a profit tax is required to replicate the first-best in order to balance the positive spillovers of innovative activity. At the second-best, the profit tax is designed to optimally respond to growth shocks above and beyond what is prescribed by the standard tax-smoothing incentives in economies with exogenous growth. The interplay of risk and innovation opens a new margin for optimal taxation.

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.