Sectoral Shocks and Asset Prices

Abstract

This paper examines the asset pricing implications of sector-specific shocks in a multi-sector economy where heterogeneous firms interact in the markets for material inputs, investment goods, and final goods. The model is solved using a third-order perturbation and is estimated by the simulated method of moments. The sparsity of the Capital Flow table implies that sectoral shocks tend to affect the most sectors that produce investment goods. However, overall, the input-output structure diffuses the sectoral shocks so that there is limited heterogeneity in ex-post mean stock returns across sectors. Sectoral productivity shocks jointly account for more than 50% of equity risk premia in all sectors with substantial heterogeneity in the contribution of sectoral shocks to the risk premia but little heterogeneity in the composition of risk premia across sectors. The model endogenously generates volatility clusters in sectoral stock returns even though all shocks are conditionally homoskedastic.