Government Investment and the Stock Market

39 Pages Posted: 19 Nov 2009 Last revised: 4 Oct 2012

Frederico Belo

University of Minnesota; National Bureau of Economic Research (NBER)

Jianfeng Yu

University of Minnesota

Date Written: May 15, 2012

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.

Keywords: q-theory, public sector capital, return predictability

JEL Classification: G12, E62, H41, G28

Suggested Citation

Belo, Frederico and Yu, Jianfeng, Government Investment and the Stock Market (May 15, 2012). Available at SSRN: https://ssrn.com/abstract=1508120 or http://dx.doi.org/10.2139/ssrn.1508120

Frederico Belo (Contact Author)

University of Minnesota ( email )

19th Avenue South
Minneapolis, MN 55455
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jianfeng Yu

University of Minnesota ( email )

321 19th Avenue
Suite 3-122
Minneapolis, MN 55455
United States

HOME PAGE: http://users.cla.umn.edu/~jianfeng/

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