Technology Shocks, Capital Reallocation Frictions and the Cross Sectional Returns

Abstract

We study the cross sectional return implications of technology shocks through the channel of capital reallocation. We present a model in which capital reallocation frictions limit the non-innovating firms' ability to redeploy assets when facing technology shocks and forces it to hold unproductive capital. Hence its value depreciates more when the reallocation frictions are higher. The frictions can further amplify firms' risk exposure to technology shocks by altering the consumption dynamics and hence the risk premium of technology shocks. Empirically, We find that non-innovating firms' stock prices respond more negatively to technology shocks in industries with higher asset liquidity, while innovating firms' responses to technology shocks do not vary with industry asset liquidity. The results shed light on the role of capital reallocation in the creative destruction process and its asset pricing implications.