Stock Price Volatility and Patent Citation Dynamics: the case of the pharmaceutical industry

Recent finance literature highlights the role of technological change in increasing firm specific and aggregate stock price volatility (Campbell et al. 2001, Shiller 2000, Pastor and Veronesi 2005). Yet innovation data is not used in these analyses, leaving the direct relationship between innovation and volatility untested. Our aim is to investigate more closely the relationship between stock price volatility and innovation using firm level patent citation data. The analysis builds on the empirical work by Mazzucato (2002; 2003) where it is found that stock price volatility is highest during periods in the industry life-cycle when innovation is the most '˜competence-destroying'. Here we ask whether firms which invest more in innovation (more R&D and more patents) and/or which have '˜more important' innovations (patents with more citations) experience more volatility. We focus the analysis on firms in the pharmaceutical and biotechnology industries between 1974 and 1999. Results suggest that there is a positive and significant relationship between idiosyncratic risk, R&D intensity and the various patent related measures. Preliminary support is also found for the '˜rational bubble' hypothesis linking both the level and volatility of stock prices to innovation