Competition, Profitability, and Discount Rates

We build an asset-pricing model with dynamic strategic competition to explain the strong joint fluctuations in aggregate discount rates, competition intensity, profitability, and asset prices. Product market competition endogenously intensifies as discount rates rise, because firms compete more aggressively for current cash flows by undercutting each other as the value of future cooperation decreases. In industries with a lower turnover rate of market leaders, firms' profit margins tend to be higher yet more exposed to discount-rate fluctuations, thereby generating the gross profitability premium. We exploit large tariff cuts to identify exogenous variation in market structure to test the core mechanism directly.

Keywords: Product-market structure, Oligopoly, Profitability premium, Leadership persistence, Tariff shocks, Price Wars.

JEL Classification: G12, L13, O33, C73

Suggested Citation: Suggested Citation

Dou, Winston Wei and Ji, Yan and Wu, Wei, Competition, Profitability, and Discount Rates (June 1st, 2020). Journal of Financial Economics (JFE), Forthcoming, The Rodney L. White Center Working Papers Series at the Wharton School, The Jacobs Levy Equity Management Center for Quantitative Financial Research Working Papers Series, Mays Business School Research Paper, Jacobs Levy Equity Management Center for Quantitative Financial Research Paper, Available at SSRN: https://ssrn.com/abstract=3309554 or http://dx.doi.org/10.2139/ssrn.3309554