The Risk of Schumpeterian Competition

We model a market penetration game where agents compete for claims to a consumption stream. We characterize how creative destruction affects risk, wealth, and prices. Competition not only imposes excessive disruption risk on existing assets and higher technological uncertainty, it also increases the duration of the consumption stream (the weighted-average maturity of wealth). Because of hedging motives, a complementarity between wealth duration and technological uncertainty decreases systematic risk. If competition is sufficiently intense, a negative risk premium may arise. The model generates price paths consistent with boom-bust patterns and transient episodes of negative expected excess returns. We discuss the implications of competition for income inequality.