Domestic AI competition: Is DeepSeek a competitor or catalyst to Chinese AI firms?

• Examines how Chinese AI firms’ stock prices responded to DeepSeek’s R1 launch in January 2025, providing insights into domestic AI competition. • Finds an inverse U-shaped market response with initial decline, mid-term gain, and later return to baseline. • Shows that firms with strong R&D capacity sustain positive stock returns after AI disruption. • Highlights that domestic AI competition rewards firms with agility and innovation capabilities. Using DeepSeek’s artificial intelligence (AI) breakthrough as a significant event, this study examines how Chinese AI firms respond to domestic disruptive competition. We find an inverse U-shaped market reaction: initial declines due to competitive concerns, medium-term gains driven by innovation hype, and long-term reversals as optimism fades. Firms with stronger R&D capacity exhibit sustained positive returns, while state-owned enterprises (SOEs) underperform despite short-term policy-driven gains. These findings highlight that sustained AI sector growth requires more than headline innovation—it hinges on robust R&D infrastructure and institutional agility.