Capital-Embodied Technological Progress and Obsolescence: The Role of Asset Valuation

Abstract

This study highlights the importance of technological progress embodied in capital goods in explaining business cycle fluctuations and stock market prices through asset valuation mechanisms. Such technological progress modifies the relative productivity of capital goods across different vintages, which is reflected in their market value. In estimating a DSGE model built on asset valuation, this study finds that investment and output increase significantly with such technological progress, as the initial negative wealth effects due to economic obsolescence of existing capital goods are more than offset by improved income prospects from new investments that generate higher payouts due to productivity enhancement. The investors’ technological shock perception crucially affects asset valuation, thereby altering the empirical results considerably. Different shock propagation mechanism analyses reveal possible asset price misalignments, namely extremely high stock market prices that are not aligned with actual capital accumulation dynamics.