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Asset Pricing in Production Economies When Capital Inputs are Heterogeneous

This paper studies asset pricing implications of heterogeneity across capital inputs. We build a general equilibrium model including two types of capital. The agents in our economy have Epstein and Zin (1989) preferences and technology is exposed to long-run risks in productivity growth. Following the literature, production inputs differ with respect to rates of depreciation and adjustment cost. We explain both, differences in returns and investment behaviour for two types of capital. Model implied asset pricing and relevant macroeconomic moments are in line with empirical data. To fully capture the effect of small but persistent shocks to the expected growth rate of productivity in a DSGE framework, the model is solved with a global non-linear solution algorithm. It is shown, when including long-run risks in productivity growth in conjunction with capital heterogeneity, using local Taylor-expansion based methods will not suffice, to obtain a satisfactory accuracy of approximation.