Competition, Profitability, and Discount Rates

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

74 Pages Posted: 14 Jan 2019 Last revised: 28 Jun 2021

See all articles by Winston Wei Dou

Winston Wei Dou

The Wharton School, University of Pennsylvania; National Bureau of Economic Research (NBER)

Yan Ji

Hong Kong University of Science & Technology (HKUST)

Wei Wu

Texas A&M University

Date Written: June 1st, 2020

Abstract

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

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

Winston Wei Dou (Contact Author)

The Wharton School, University of Pennsylvania ( email )

2318 Steinberg Hall - Dietrich Hall
3620 Locust Walk
Philadelphia, PA 19104
United States

HOME PAGE: http://finance-faculty.wharton.upenn.edu/wdou/

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

HOME PAGE: http://www.nber.org/people/winston_wei_dou?page=1&perPage=50

Yan Ji

Hong Kong University of Science & Technology (HKUST) ( email )

Clearwater Bay
Kowloon, 999999
Hong Kong

Wei Wu

Texas A&M University ( email )

360M Wehner
College Station, TX 77843-4218
United States
979-862-8092 (Phone)

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