OPTIMAL PRODUCTION OF INNOVATIONS UNDER UNCERTAINTY

The paper reports results on a risk-neutral firm's research incentives . When unrelated to the firm's own stake in the program, the risks enc ourage or discourage risky research spending, depending on the propert ies of the research technology available. A non-decreasing time path o f information builds the idea of an asymmetric probability distributio n of the state of knowledge into the model. It follows that the requir ed return on risky investments may actually fall short of the safe ret urn. Since it is the upside risk that dominates, increased controllabl e risks will increase incentives for risky innovative activity. It is proved, but only in a more restricted framework (with differentiable p rocesses), that the expectational effects involved will strengthen the positive relationship between controllable risks and the expected ret urn.