Patents, R and D, and the Stock Market Rate of Return

The purpose of this paper is to present and estimate a model which allows one to use the recently computerized U.S. Patent Office's data base to identify when and where changes in inventive output have occurred. The model assumes a firm which chooses a research strategy to maximize the expected discounted value of the net cash flows from its activities, and a stock market that evaluates this expectation at different dates (it is a version of the Lucas-Prescott, 1971, investment model). Patents are taken as an indicator of the output of the firm's research laboratories. These assumptions place a set of testable restrictions on the stochastic process generating patents, R&D, and the stock market rate of return on the firm's equity (the econometric framework used is that of a restricted index, or dynamic factor-analysis model [Sargent and Sims, 1977; Geweke, 1977b]). The data contain observations on these three variables for 120 firms over an eight year period. The model fits these data quite well and the final section reports on the implications of the parameter estimates.