Innovation and Idiosyncratic Risk: an Industry and Firm Level Analysis

Recent studies find that idiosyncratic risk (IR), the degree to which firm specific returns are more volatile than aggregate market returns, has increased since the 1960’s and attribute this to economy wide factors such as the role of the IT revolution. To gain further insights into why IR has increased over time, our paper uses industry level data and firm level data to study if firms and industries that are more R&D intensive are characterized by higher IR due to how the process of innovation affects the uncertainty of expected future profits. While the industry level results prove inconclusive, the firm level results are encouraging: a clear relationship is found between a firm’s R&D intensity and the volatility of its returns.