An Adjustment Cost Model of Asset Pricing

Parantap Basu

International Economic Review, 1987, vol. 28, issue 3, 609-21

Abstract: An intertemporal asset-pricing model is constructed incorporating an explicit adjustment-cost technology. The capital stock can be altered by investment, but there are adjustment costs whi ch lower the marginal return of investment. In a model involving an i nfinitely-lived representative agent, it is shown how changes in adju stment costs influence asset prices, the term structure of real inter est rates, and risk premia. The results suggest that adjustment cost, by causing an intertemporal consumption substitution, raises the pri ces of risky stocks and risk premia and reduces long-term real intere st rates. Copyright 1987 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

Date: 1987
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