Government debt and the returns to innovation

Abstract

Elevated levels of US government debt in the aftermath of the great recession have raised concerns about their effects on long-term growth prospects. By empirically identifying measures of government indebtedness as risk factors priced in stock returns, we document and theoretically evaluate a novel risk channel at work shaping this link.In the cross-section, stocks earn positive premia for their exposure to movements in government debt, while these predict high stock returns going forward in the time series. A substantial return spread between the most and the least innovative firms is increasing in the debt-to-gdp ratio. We show that rises in the cost of capital for innovation-intensive firms associated with elevated government debt bring about declines in R&D activity and economic growth. We interpret these findings through the lens of a production-based asset pricing model with endogenous innovation and fiscal policy. The model emphasizes the role of political and fiscal uncertainty in shaping the empirical relationships.

The U.S. Public Debt Valuation Puzzle

“…Liu, Schmid, and Yaron (2020) argue that increasing safe asset supply can be risky as more government debt increases corporate default risk premia despite providing more convenience. Croce, Nguyen, Raymond, and Schmid (2019) study cross-sectional differences in firms' exposure to government debt. Corhay, Kind, Kung, and Morales (2018) study how quantitative easing affects inflation by changing the maturity structure of government debt.…”

Is language an economic institution? Evidence from R&D investment

“…Our study also contributes to the growing literature on the determinants of corporate innovation (e.g.,Hsu et al, 2014;Luong et al, 2017;Bhattacharya et al, 2017) by suggesting that the language of corporate managers is an important driver of corporate R&D investment. In addition, our study adds to the literature on the positive relation between R&D and firm stock returns (e.g.,Cohen et al, 2013;Gu, 2016;Croce et al, 2019). Specifically, our evidence suggests that the language of corporate managers may affect stock returns through decisions on R&D investment.…”

Debt-by-Price Ratio, End-of-Year Economic Growth, and Long-Term Prediction of Stock Returns

“…For instance, a limited number of studies examine the impact of fiscal policy on stock prices in the Canadian and US stock markets [27][28][29]. Furthermore, a positive relationship between debt-to-GDP ratio and risk premiums for high R&D firms using the cross-section of stock returns has been confirmed [23]. In this research, by examining a long list of debt related covariates, debt-by-price ratio shows exceptional performance in forecasting US stock returns such that an increase in debt-by-price ratio is associated with a rise in excess stock returns.…”

“…The sample period is 1947-2020. This work is inspired by the research on valuation ratios which connect stock prices to their cash flows, namely, dividend-by-price and earnings-by-price ratios, e.g., [17][18][19][20][21]; price-by-GDP ratio [22], which is the combination of valuation ratios and macroeconomic variables due to the belief that changes in aggregate dividends or earnings are linked with the aggregate output in the economy; the recent literature on the relationship between government debt and expected returns, e.g., [23]; the importance of information stored in the end-of-year economic growth [14].…”