50 Pages Posted: 18 Jan 2015 Last revised: 16 May 2017
Date Written: May 15, 2017
When markups are high, new innovators can aggressively undercut incumbents to capture market share. Sensitivity to entry risk intensifies during times of high profit margins, and in high average markup industries. We show that strategic interactions among firms in product markets provide a risk amplification mechanism and an endogenous source of time-varying risks. Our estimated general equilibrium asset pricing model explains a sizable equity premium, predictable excess returns, and an initially downward-sloping term structure of equity. Consistent with the data, the model predicts that higher markups are associated with higher expected returns, both in the time-series and in the cross-section.
Keywords: Imperfect competition, strategic interactions, time-varying risk premia, stock return predictability, markups, entry and exit, recursive preferences
Suggested Citation: Suggested Citation
Corhay, Alexandre and Kung, Howard and Schmid, Lukas, Competition, Markups and Predictable Returns (May 15, 2017). Available at SSRN: https://ssrn.com/abstract=2550981 or http://dx.doi.org/10.2139/ssrn.2550981