Asset Pricing with Misallocation

93 Pages Posted: 10 Apr 2020 Last revised: 3 Jan 2022

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)

Di Tian

Department of Economics at University of Pennsylvania

Pengfei Wang

Peking University HSBC Business School

Date Written: August 23, 2021

Abstract

We develop an endogenous growth model with heterogeneous firms, intermediate goods, and financial frictions, in which misallocation emerges explicitly as a crucial state variable. In equilibrium, misallocation endogenously generates long-run uncertainty about economic growth by distorting innovation decisions, leading to significant welfare losses and risk premia in capital markets. Macroeconomic shocks that affect misallocation are likely to have overly persistent effects on aggregate growth. Using an empirical misallocation measure motivated by the model, we find evidence showing that misallocation captures low-frequency variations in both aggregate growth and stock returns. Empirically, a two-factor model with market and misallocation factors prices size, book-to-market, momentum, and bond portfolios with an R-squared and a mean absolute pricing error close to the Fama-French three-factor model.

Keywords: Agency conflicts, Distribution of firms, Financial frictions, Misallocation, Endogenous growth, Macro finance.

JEL Classification: L11, O30, O40.

Suggested Citation

Dou, Winston Wei and Ji, Yan and Tian, Di and Wang, Pengfei, Asset Pricing with Misallocation (August 23, 2021). Available at SSRN: https://ssrn.com/abstract=3540012 or http://dx.doi.org/10.2139/ssrn.3540012

Winston Wei Dou (Contact Author)

The Wharton School, University of Pennsylvania ( email )

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United States

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

National Bureau of Economic Research (NBER) ( email )

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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

Di Tian

Department of Economics at University of Pennsylvania ( email )

160 McNeil Building
3718 Locust Walk
Philadelphia, PA 19104
United States

Pengfei Wang

Peking University HSBC Business School ( email )

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