Is There A Shortfall in Public Investment? An Asset Pricing Appraisal

79 Pages Posted: 18 May 2017 Last revised: 16 Sep 2019

See all articles by Chao Zi

Chao Zi

University of Illinois at Urbana-Champaign

Date Written: August 31, 2019

Abstract

Is investment in public sector capital inadequate in the U.S.? The answer is yes from investors' perspective. This paper takes an asset pricing approach to evaluating the overall (in)adequacy of public sector investment. I propose a two-sector general equilibrium model that demonstrates how the share of public sector capital may enter the pricing kernel. From this theory I derive a factor pricing model with shocks to the public sector investment share ("PUB shocks") as a risk factor. I confront the factor model with a variety of test assets and find that PUB shocks are priced and carry a consistently positive price of risk. I find further support from the analysis of a sample of U.S. government contractors: I postulate that the extent to which a firm depends on government customers for revenue is a relevant proxy for its exposure to public sector investment. I find that high-dependency firms (that is, firms with greater sales to government relative to their total sales) provide a 7.4% higher average return annually compared to low-dependency firms. A subsample analysis reveals that this return spread is widening as the public sector investment share declines; it implies a growing shortfall in public sector investment in recent years.

Keywords: Public Investment, Asset Prices, Uncertainty, Flight to Safety

JEL Classification: E44, E62, G00, G18

Suggested Citation

Zi, Chao, Is There A Shortfall in Public Investment? An Asset Pricing Appraisal (August 31, 2019). Available at SSRN: https://ssrn.com/abstract=2970030 or http://dx.doi.org/10.2139/ssrn.2970030

Chao Zi (Contact Author)

University of Illinois at Urbana-Champaign ( email )

1206 South Sixth Street
Champaign, IL 61820
United States

HOME PAGE: http://czi.finance

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