Creative Destruction and Asset Prices

This paper introduces Schumpeter’s idea of creative destruction into asset pricing.The key point of our model is that small and value firms are more likelydestroyed during technological revolutions, resulting into higher expected returnsfor these stocks. A two-factor model including market return and patentactivity growth - the proxy for creative destruction risk - accounts for a largeportion of the cross-sectional variation of size and book-to-market sorted portfoliosand prices HML and SMB. The expected return difference between assetswith the highest and lowest exposure to creative destruction risk amounts to8.6 percent annually...