Putty–clay technologyandstockmarketvolatility

Firms’ first-orderconditionsimplythatstockreturnsequalinvestmentreturnsfromthe productiontechnology.Muchappliedworkusestheadjustmentcosttechnology,which impliesthattherealizedreturnishighwhentheinvestment-capitalratioishigh.This paper derives,foranarbitrarystochasticdiscountfactor,theinvestmentreturnimplied by theputty–claytechnology.Thecombinationofcapitalheterogeneityandirreversi- bility createsanovelchannelforreturnvolatility.Theinvestmentreturnishighwhen the ratioofinvestmenttogrossjobcreationislow.Empirically,theputty–clayfeature helpsaccountforU.S.stockmarketdata