Is ambiguity aversion bad for innovation?

Abstract

Not necessarily. I consider two firms that compete both on the research market and on the product market. Assuming the product market outcome is ambiguous, i.e., uncertainty is described by multiple distribution of outcomes, I show that an increase in firms' ambiguity aversion increases the ex ante likelihood that they invest in R&D. An increase in their risk aversion on the other hand decreases innovation. The result holds when the innovation has a business-stealing effect as in a Cournot duopoly with vertical differentiation. The key intuition is that ambiguity aversion exacerbates the competitive threat whereas risk aversion diminishes the profit incentive to invest. In addition to showing that an increase in ambiguity aversion leads to more projects being pursued, I show that an increase in ambiguity aversion can lead to an increase in investment for incremental projects. In the case of more radical projects, an increase in ambiguity aversion can, but not necessarily, lead to lower investment in equilibrium. Overall, ambiguity aversion has a positive effect on most innovative projects but can sometimes have a negative effect on some of the more radical, game-changing ones.