Innovation, product cycle, and asset prices

• I introduce stochastic imitation to an endogenous growth model.
• The composition of product changes over the business cycle.
• The model is able to match the equity premium data with a recursive utility.

This paper constructs a simple endogenous growth model featuring the product cycle, i.e., the transition from monopoly to perfect competition, and studies its implications for both asset market and business cycle statistics. I find that the product cycle is a powerful amplification mechanism; the model incorporating the product cycle is able to generate nearly twice as large an equity premium as the model without the product cycle and, as a result, matches the equity premium data. The current paper thereby contributes to advancing a promising theory on the economic sources of long-run risks, postulating that innovation and R&D cause long-run uncertainties in economic growth.