Financial Market Concentration and Misallocation
65 Pages Posted: 24 Jan 2019 Last revised: 20 Jul 2023
Date Written: November 1, 2020
Abstract
How does financial market concentration affect capital allocation? We propose a complete-markets model in which real investment and financial price impact are jointly determined in general equilibrium. We identify a two-way feedback mechanism whereby price impact induces misallocation and misallocation raises price impact. The mechanism is stronger if productivity is low or productivity dispersion is high. Given rising dispersion, the model can rationalize trends in corporate discount rates, cash holdings, investment, asset prices, and capital reallocation over the last two decades, even when market concentration is relatively stable. Overall, our findings suggest that financial market concentration may hamper allocative efficiency.
Keywords: financial market concentration, capital misallocation, investment, asset prices, market power
JEL Classification: E22, E44, G11, G12, G20
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