The Oligopoly Lucas Tree: Consumption Risk and Industry-Level Risk Exposure

Joint with Yan Ji, Wei Wu

August 2020

We analyze the quantitative asset pricing implications of industry concentration and strategic rivalry by embedding oligopolistic competition into an endowment economy. Rivalry intensity endogenously increases as the discount rate (expected growth) rises (declines), because peers care less about future cooperation. In theory and data, we decompose industries' exposure to consumption risk into two components, reflecting news about expected growth and discount rates. More profitable (value) industries are more exposed to discount-rate (expected-growth) fluctuations. The industry-level gross profitability and value premium become more pronounced after controlling for the book-to-market ratio and gross profitability, respectively. Finally, we exploit the exogenous variation in industries' market structures and growth dynamics instrumented using unexpected large tariff cuts and natural disasters to test the central mechanisms.