Innovation and Idiosyncratic Risk

Abstract

The paper studies whether “idiosyncratic riskâ€, i.e. the degree to which firm and industry specific returns are more volatile than aggregate market returns, is higher in innovative industries which are characterized by more risk and uncertainty. Volatility is studied both at the industry level (for 34 different industries from 1974-2003) and at the firm level (for 5 industries with different levels of innovativeness: biotech, pharmaceuticals, computers, textile, agriculture). Findings are mixed. A relationship between innovation and volatility emerges most strongly with firm level data, when firm dimension is accounted for, and when time varying volatility is explicitly studied via GARCH analysis. The latter highlights the distinctive behavior of returns during the course of the industry life-cycle.idiosyncratic risk, volatility, innovation, industry life cycle