BIAS IN MARKET RESEARCH-AND-DEVELOPMENT PORTFOLIOS

Based on a simple 'contest' model of product innovation, we find that, in accordance with conventional wisdom, and contrary to much of the previous theoretical literature, market competition implies an equilibrium level of risk which is too low from society's standpoint. The intuition is that the divergence between private and social marginal benefits from R&D is greater the greater the probability of discovery by the rival firms; and this probability is higher for lower risk projects.