Investment Shocks and Asset Prices
01 Aug 2011-Journal of Political Economy (University of Chicago PressChicago, IL)-Vol. 119, Iss: 4, pp 639-685
TL;DR: In this paper, the authors explore the implications for asset prices and macroeconomic dynamics of shocks that improve real investment opportunities and thus affect the representative household's marginal utility and find that a positive investment shock leads to high marginal utility states.
Abstract: I explore the implications for asset prices and macroeconomic dynamics of shocks that improve real investment opportunities and thus affect the representative household’s marginal utility. These investment shocks generate differences in risk premia due to their heterogeneous impact on firms: they benefit firms producing investment relative to firms producing consumption goods and increase the value of growth opportunities relative to the value of existing assets. Using data on asset returns, I find that a positive investment shock leads to high marginal utility states. A general equilibrium model with investment shocks matches key features of macroeconomic quantities and asset prices.
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TL;DR: This paper used newly collected data on patents issued to U.S. firms in the 1926 to 2010 period, combined with the stock market response to news about patents, to measure the economic importance of each innovation.
Abstract: We propose a new measure of the economic importance of each innovation. Our measure uses newly collected data on patents issued to U.S. firms in the 1926 to 2010 period, combined with the stock market response to news about patents. Our patent-level estimates of private economic value are positively related to the scientific value of these patents, as measured by the number of citations the patent receives in the future. Our new measure is associated with substantial growth, reallocation, and creative destruction, consistent with the predictions of Schumpeterian growth models. Aggregating our measure suggests that technological innovation accounts for significant medium-run fluctuations in aggregate economic growth and TFP. Our measure contains additional information relative to citation-weighted patent counts; the relation between our measure and firm growth is considerably stronger. Importantly, the degree of creative destruction that is associated with our measure is higher than previous estimates, confirming that it is a useful proxy for the private valuation of patents.
870 citations
TL;DR: In this paper, the authors developed a model in which the outside option of the key talent determines the share of firm cash flows that accrue to shareholders, and found that firms with more organization capital have average returns that are 4.6% higher than firms with less organization capital.
Abstract: Organization capital is a production factor that is embodied in the firm's key talent and has an efficiency that is firm specific. Hence, both shareholders and key talent have a claim to its cash flows. We develop a model in which the outside option of the key talent determines the share of firm cash flows that accrue to shareholders. This outside option varies systematically and renders firms with high organization capital riskier from shareholders' perspective. We find that firms with more organization capital have average returns that are 4.6% higher than firms with less organization capital.
648 citations
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TL;DR: In this article, the authors estimate a New-Neoclassical Synthesis model of the business cycle with two investment shocks and find that one of them is an investment-specific technology shock that affects the transformation of consumption into investment goods and is identified with the relative price of investment.
Abstract: We estimate a New-Neoclassical Synthesis model of the business cycle with two investment shocks. The first, an investment-specific technology shock, affects the transformation of consumption into investment goods and is identified with the relative price of investment. The second shock affects the production of installed capital from investment goods or, more broadly, the transformation of savings into future capital input. We find that this shock is the most important driver of U.S. business cycle fluctuations in the postwar period and that it is likely to proxy for more fundamental disturbances to the functioning of the financial sector. To corroborate this interpretation, we show that the shock correlates strongly with interest rate spreads and that it played a particularly important role in the recession of 2008.
201 citations
TL;DR: In this paper, the authors explore the impact of investment-specific technology (IST) shocks on the cross section of stock returns and show that IST shocks have a differential effect on the value of assets in place and value of growth opportunities.
Abstract: We explore the impact of investment-specific technology (IST) shocks on the cross section of stock returns. Using a structural model, we show that IST shocks have a differential effect on the value of assets in place and the value of growth opportunities. This differential sensitivity to IST shocks has two main implications. First, firm risk premia depend on the contribution of growth opportunities to firm value. Second, firms with similar levels of growth opportunities comove with each other, giving rise to the value factor in stock returns and the failure of the conditional CAPM. Our empirical tests confirm the model's predictions.
183 citations
TL;DR: In this article, the impact of labor market frictions on asset prices was studied and an investment-based model with stochastic labor adjustment costs was proposed to explain the finding that firms with high hiring rates are expanding firms that incur high adjustment costs.
Abstract: We study the impact of labor market frictions on asset prices. In the cross section of US firms, a 10 percentage point increase in the firm’s hiring rate is associated with a 1.5 percentage point decrease in the firm’s annual risk premium. We propose an investment-based model with stochastic labor adjustment costs to explain this finding. Firms with high hiring rates are expanding firms that incur high adjustment costs. If the economy experiences a shock that lowers adjustment costs, these firms benefit the most. The corresponding increase in firm value operates as a hedge against these shocks, explaining the lower risk premium of these firms in equilibrium.
169 citations
References
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TL;DR: In this article, the authors identify five common risk factors in the returns on stocks and bonds, including three stock-market factors: an overall market factor and factors related to firm size and book-to-market equity.
24,874 citations
"Investment Shocks and Asset Prices" refers background or methods in this paper
...Panel A shows estimates of the parameters using the cross section of 25 portfolios sorted on market equity and book-to-market from Fama and French (1993)....
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...The finance literature has extensively documented the value premium puzzle, namely, the finding that firms with high book equity to market equity ratios (book-to-market) have substantially higher average returns than firms with low book-to-market (Fama and French 1993)....
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...Furthermore, Fama and French (1993) show that a portfolio of value minus growth firms is a separate risk factor in the time series of returns, in addition to the market portfolio....
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...…test, I also estimate the parameters of the stochastic discount factor (40) using a set of assets that are more standard in the finance literature: the cross section of 25 size and book-tomarket portfolios of Fama and French (1993) and the 30 industry portfolios of Fama and French (1997)....
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...The return spread between the value and growth firms is driven only by the investment shock Z; thus my model naturally generates a value factor, explaining the pattern of comovement documented by Fama and French (1993)....
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TL;DR: In this paper, the authors show that standard errors of more than 3.0% per year are typical for both the CAPM and the three-factor model of Fama and French (1993), and these large standard errors are the result of uncertainty about true factor risk premiums and imprecise estimates of the loadings of industries on the risk factors.
6,064 citations
"Investment Shocks and Asset Prices" refers methods in this paper
...…test, I also estimate the parameters of the stochastic discount factor (40) using a set of assets that are more standard in the finance literature: the cross section of 25 size and book-tomarket portfolios of Fama and French (1993) and the 30 industry portfolios of Fama and French (1997)....
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...Panel B shows results using the cross section of 30 industry portfolios of Fama and French (1997)....
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Posted Content•
TL;DR: The authors constructs a simple neoclassical model of intrinsic business cycle dynamics in which borrowers' balance sheet positions play an important role and shows that the agency costs of undertaking physical investments are inversely related to the entrepreneur's/borrower's net worth.
Abstract: This paper constructs a simple neoclassical model of intrinsic business cycle dynamics in which borrowers' balance sheet positions play an important role. The critical insight is that the agency costs of undertaking physical investments are inversely related to the entrepreneur's/borrower's net worth. As a result, accelerator effects on investment emerge: Strengthened borrower balance sheets resulting from good times expand investment demand, which in turn tends to amplify the upturn; weakened balance sheets in bad times do just the opposite. Further, redistributions or other shocks that affect borrowers' balance sheets (as in a debt-deflation} may have aggregate real effects.
4,286 citations
TL;DR: In this paper, a class of recursive, but not necessarily expected utility, preferences over intertemporal consumption lotteries is developed, which allows risk attitudes to be disentangled from the degree of inter-temporal substitutability, leading to a model of asset returns in which appropriate versions of both the atemporal CAPM and the inter-time consumption-CAPM are nested as special cases.
Abstract: This paper develops a class of recursive, but not necessarily expected utility, preferences over intertemporal consumption lotteries An important feature of these general preferences is that they permit risk attitudes to be disentangled from the degree of intertemporal substitutability Moreover, in an infinite horizon, representative agent context these preference specifications lead to a model of asset returns in which appropriate versions of both the atemporal CAPM and the intertemporal consumption-CAPM are nested as special cases In our general model, systematic risk of an asset is determined by covariance with both the return to the market portfolio and consumption growth, while in each of the existing models only one of these factors plays a role This result is achieved despite the homotheticity of preferences and the separability of consumption and portfolio decisions Two other auxiliary analytical contributions which are of independent interest are the proofs of (i) the existence of recursive intertemporal utility functions, and (ii) the existence of optima to corresponding optimization problems In proving (i), it is necessary to define a suitable domain for utility functions This is achieved by extending the formulation of the space of temporal lotteries in Kreps and Porteus (1978) to an infinite horizon framework A final contribution is the integration into a temporal setting of a broad class of atemporal non-expected utility theories For homogeneous members of the class due to Chew (1985) and Dekel (1986), the corresponding intertemporal asset pricing model is derived
4,218 citations
"Investment Shocks and Asset Prices" refers background in this paper
...time analogue of Epstein and Zin (1989) preferences....
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TL;DR: In this paper, a consumption-based model is proposed to explain a wide variety of dynamic asset pricing phenomena, including the procyclical variation of stock prices, the long-term horizon predictability of excess stock returns, and the countercyclical variations of stock market volatility.
Abstract: We present a consumption†based model that explains a wide variety of dynamic asset pricing phenomena, including the procyclical variation of stock prices, the long†horizon predictability of excess stock returns, and the countercyclical variation of stock market volatility. The model captures much of the history of stock prices from consumption data. It explains the short†and long†run equity premium puzzles despite a low and constant risk†free rate. The results are essentially the same whether we model stocks as a claim to the consumption stream or as a claim to volatile dividends poorly corelated with consumption. The model is driven by an independently and identically distributed consumption growth process and adds a slow †moving external habit to the standard power utility function. These features generate slow countercyclical variation in risk premia. The model posits a fundamentally novel description of risk premia. Investors fear stocks primarily because they do poorly in recessions unrelated to the risks of long†run average consumption growth.
3,886 citations