Competition, Profitability, and Risk Premia

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

67 Pages Posted: 14 Jan 2019 Last revised: 16 Sep 2019

See all articles by Winston Dou

Winston Dou

The Wharton School, University of Pennsylvania

Yan Ji

Hong Kong University of Science & Technology (HKUST)

Wei Wu

Texas A&M University - Department of Finance

Date Written: September 13, 2019

Abstract

We build a general equilibrium model with dynamic strategic competition to reconcile competition intensity, profitability, and returns. Product market competition endogenously intensifies as discount rates rise and expected consumption growth declines, because firms compete more aggressively for current cash flows by undercutting each other as the present value of future cooperation decreases. The intensified competition amplifies the impact of the aggregate shocks driving discount rates and expected consumption growth. In industries with lower turnover rates of market leaders, firms' profit margins are higher and more exposed to discount rate and expected growth fluctuations, thereby generating the gross profitability premium.


Keywords: Product market friction, Habits, Competition intensity, Gross profitability premium, Time-varying risk premium

JEL Classification: G12, L13, O33, C73

Suggested Citation

Dou, Winston and Ji, Yan and Wu, Wei, Competition, Profitability, and Risk Premia (September 13, 2019). The Jacobs Levy Equity Management Center for Quantitative Financial Research Working Papers Series; Mays Business School Research Paper. Available at SSRN: https://ssrn.com/abstract=3309554 or http://dx.doi.org/10.2139/ssrn.3309554

Winston Dou (Contact Author)

The Wharton School, University of Pennsylvania ( email )

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

Yan Ji

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

Clearwater Bay
Kowloon, 999999
Hong Kong

Wei Wu

Texas A&M University - Department of Finance ( email )

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

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