Competition, Markups and Predictable Returns

Abstract

This paper jointly examines the link between competition and expected returns in the time series and in the cross section. To this end, we build a general equilibrium model where markups vary because of firm entry with oligopolistic competition. When concentration is high, markups are more sensitive to entry risk. We find that higher markups are associated with higher expected returns over time and across industries, in line with the data. The model can also quantitatively account for the persistent rise in aggregate risk premia and macroeconomic volatility associated with the secular increase trend industry concentration since the mid 1980s.

Keywords: Production-based asset pricing, imperfect competition, time-varying risk premia, stock return predictability, recursive preferences