Reallocating patents to firms more proficient in their utilization can improve welfare. Moreover, the timing of such trades significantly impacts innovation outcomes. I construct a unique dataset that captures interactions between patent trades and the drug development within the U.S. pharmaceutical sector, and find that 72% of patents are traded before the associated drug hits the market. Drugs involved in patent trades are also more likely to advance to the launch stage compared to those without patent trades. I construct a dynamic structural model for the development process of a new drug, taking into account crucial factors such as trade dynamics, firms’ comparative advantages, transaction costs, and search frictions at various stages of the development process, encompassing discovery, clinical trials, FDA approval, and product launch. The estimation of this model reveals that (i) firms with greater stage-specific experience enjoy reduced development costs at the corresponding stage; (ii) transferring patents to firms with lower development costs enhances the likelihood of a drug advancing to subsequent stages; and (iii) market frictions in patent trading exhibit significant variation across different phases of drug development, with transaction costs reaching their peak prior to FDA registration. Counterfactual analyses show that reducing transaction costs within the patent market at pivotal stages significantly increases the likelihood of drug success and the market value of the drug.

Does technology trade encourage or discourage innovations? Previous studies indicate that technology trade increases welfare by reallocating patents to better matched firms. Using patent application and reassignment data in the U.S. pharmaceutical industry, this paper develops a dynamic structural model to estimate the impact of patent trade on subsequent innovation decisions. The patents bought by a firm can be used as a substitute to own innovation, or as a complement to speed up the development of new ideas. By allowing the patents created within the firm and bought from others to work differently on a firm’s production of goods and on generating new ideas, I find evidence that both patented and non patented knowledge capital (KC) positively contribute to the production of output, though the former has much stronger effect in the production of ideas. While self-generated KC plays a complementary role in future innovation, the KC bought from others is used as substitutes to self-generated KC. A counterfactual exercise is conducted to predict how frictions in the patent market affect future innovation outcomes. Lowering transaction cost in the patent trade market by 50%, I find both producers and non producers participate more actively in the market but in a different way. Producers increase more the stock of patent bought while non producers increase the stock of patent selling. In the long run, lower transaction cost has negative impact on producer’s innovation decisions but increases non producer’s patentable innovation ideas.