Competition, Profitability, and Discount Rates
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
74 Pages Posted: 14 Jan 2019 Last revised: 10 Sep 2020
Date Written: June 1st, 2020
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
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