Journal of Monetary Economics2013-09-05 2:57 AM

Government investment and the stock market

Highlights • Government investment in public capital forecasts high risk premiums. • Result is in contrast with negative link between private investment and risk premiums. • Propose a neoclassical investment-based model augmented with public capital. • Model matches the data if public capital increases productivity of private inputs. Abstract High rates of government investment in public sector capital forecast high risk premiums both at the aggregate and firm-level. This result is in sharp contrast with the well-documented negative relationship between the private sector investment rate and risk premiums. To explain the empirical findings, we extend the neoclassical q-theory model of investment and specify public sector capital as an additional input in the firm's technology. We show that the model can quantitatively replicate the empirical facts with reasonable parameter values if public sector capital increases the marginal productivity of private inputs.

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Journal of Monetary Economics

The Journal of Monetary Economics is a peer-reviewed academic journal covering research on macroeconomics and monetary economics. It is published by Elsevier and was established in October 1973 by Karl Brunner and Charles I. Plosser.

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