Putty-Clay Technology and Stock Market Volatility

I derive a production-based asset pricing formula to infer aggregate stock market returns from macroeconomic time series when the technology is putty-clay. Capital heterogeneity leads to variation in the aggregate stock market value through a new compositional e¤ect. The asset pricing formula, which holds regardless of the stochastic discount factor, predicts that the stock market value is high when the ratio of investment to gross job creation is low. This contrasts with the adjustment cost model which predicts that the stock market value is high when the investment-capital ratio is high. Incorporating the putty-clay technology substantially increases the ability of the adjustment cost model to match the data on U.S. stock returns.