Capital Heterogeneity, Time-to-Build, and Return Predictability

Abstract

I study how and why the two major types of business investment, equipment investment and structures investment, are differently linked to stock returns. I empirically show that equipment investment has a significantly stronger predictive power for stock market returns than structures investment, both in-sample and out-of-sample. To explain this empirical finding, I build a general equilibrium production model featuring a shorter time-to-build for equipment investment than for structures investment. In the model, equipment investment reacts to productivity shocks in a more timely manner, and reflects more of the information contained in stock prices.