Industrial Asset Pricing with Endogenous Business Cycles
36 Pages Posted: 29 Nov 2011 Last revised: 17 Jul 2014
Date Written: December 11, 2011
We develop a dynamic general equilibrium model with many different industries, in which firms set prices strategically in product markets. Our approach extends previous literature by endogenizing the market price of risk and allowing for more general risk structures. General equilibrium in the model is shown to exist under general conditions. Strategic interaction between firms amplifies business cycles, small changes in long-term growth rates can have drastic effects on the equilibrium outcome, whereas temporary changes in productivity have marginal impact, and the overall competitiveness of the economy only depends on long-term growth. A firm's expected returns are affected by the industrial environment in which it operates, in line with what has been observed in the empirical literature. Overall, our model suggests that industry characteristics should be informative about the expected returns of individual firms over the business cycle.
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