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This paper proposes and tests a new source of time variation in real investment opportunities, namely long-run shocks to the productivity of the investment sector, to explain the joint behavior of macroeconomic quantities and asset prices. A two-sector general equilibrium model with long-run investment shocks and wage rigidities produces both positive co-movement among key macroeconomic variables and a sizable return volatility differential between the investment and consumption sector. Moreover, positive long-run investment shocks are associated with low marginal utility and thus command a positive risk premium. We test our model using data on sectoral TFP and find evidence in support of our theoretical predictions.

JEL Codes: E32, G12.

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