Abstract
Technology choice allows for substitution of production across states of nature and depends on state-dependent risk aversion. In equilibrium, endogenous technology choice can counter a persistent negative productivity shock with an increase in investment. An increase in risk aversion intensifies transformation across states, which directly leads to higher investment volatility. In our model and the data, the conditional volatility of investment correlates negatively with the price-dividend ratio and predicts excess stock market returns. In addition, the same mechanism generates predictability of consumption growth and produces fluctuations in the risk-free rate.
| Original language | English |
|---|---|
| Pages (from-to) | 2483-2499 |
| Number of pages | 17 |
| Journal | Management Science |
| Volume | 67 |
| Issue number | 4 |
| DOIs | |
| State | Published - Apr 2021 |
| Externally published | Yes |
Bibliographical note
Funding Information:History: Accepted by Gustavo Manso, finance. Funding: The authors acknowledge financial support from the Center for Asset Pricing Research at BI Norwegian Business School. Part of this research was conducted while P. Ehling was visiting at The Wharton School and Nanyang Business School. Supplemental Material: The online appendices are available at https://doi.org/10.1287/mnsc.2019.3561.
Publisher Copyright:
© 2020 INFORMS
Keywords
- Conditional volatility of investment
- Predictability of returns
- State-contingent technology
- Time-varying risk aversion
ASJC Scopus subject areas
- Strategy and Management
- Management Science and Operations Research