The Oligopoly Lucas Tree: Quantitative Asset Pricing Implications

Joint with Yan Ji, Wei Wu

May 2020

We develop a novel quantitative asset pricing framework with concentrated industries, consumer inertia, and strategic competition, in which competition intensity endogenously intensifies as the expected growth declines or the discount rate rises, because firms compete more aggressively for current cash flows by undercutting each other as the present value of future cooperation decreases. We quantitatively decompose the beta of stock returns with the consumption risk into two components, reflecting news about the expected growth and discount rate. In equilibrium, more profitable industries have higher exposure to the discount-rate component of consumption risk because of higher consumer inertia, while value industries have higher exposure to the expected-growth component. More important, after controlling for the book-to-market ratio, the gross profitability premium becomes more pronounced. Finally, we exploit exogenous variation in market structures and growth loadings, such as large tariff cuts and natural disasters, to test the core competition and growth mechanisms directly.