Article | Management Science | April 2017

Financing Risk and Innovation

by Ramana Nanda and Matthew Rhodes-Kropf


We provide a model of investment into new ventures that demonstrates why some places, times, and industries should be associated with a greater degree of experimentation by investors. Investors respond to financing risk―a forecast of limited future funding―by modifying their focus to finance less innovative firms. Potential shocks to the supply of capital create the need for increased upfront financing, but this protection lowers the real option value of the new venture. In equilibrium, financing risk disproportionately impacts innovative ventures with the greatest real option value. We propose that extremely novel technologies may need "hot" financial markets to get through the initial period of discovery or diffusion.

Keywords: Risk and Uncertainty; Financing and Loans; Innovation and Invention;


Nanda, Ramana, and Matthew Rhodes-Kropf. "Financing Risk and Innovation." Management Science 63, no. 4 (April 2017): 901–918.