Investment - specific shocks , firm characteristics and the cross - section of returns ∗

We analyze comovement in stock returns among firms with similar past investment rates or profitability. We argue that technological shocks in the investment-good sector are a significant source of such comovement. The market value of a firm’s growth opportunities and the market value of its existing assets have different exposures to the investment-specific technology (IST) shocks. Past investment and profitability are informative about the share of growth opportunities in the firm’s market value, and are therefore correlated with the firm’s exposure to IST shocks. We find empirical support for this argument, and use a structural model to show that this mechanism is quantitatively significant. ∗We thank Ryan Israelsen for sharing with us the quality-adjusted investment goods price series. Dimitris Papanikolaou thanks the Zell Center for financial support. Leonid Kogan thanks J.P. Morgan for financial support. †NBER and MIT Sloan School of Management, [email protected] ‡Kellogg School of Management, [email protected]