Technology Adoption and the Capital Age Spread∗

We explore the asset pricing implications of an investment-based model that features a stochastic technology frontier and costly technology adoption. Firms adopt the latest technology embodied in new capital to reach a stochastic technology frontier, but this decision entails an adoption cost. The model predicts that old capital firms are more risky and hence offer a higher returns than young capital firms. This is because old capital firms are more likely to upgrade their capital in the near future and hence are more exposed to shocks driving the technology frontier. Our empirical analysis supports the model’s predictions. We find an annual return spread of 7% between old and young capital firms. The CAPM fails in explaining this return spread. JEL Classification: E23, E44, G12