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Competition, profitability, and discount rates

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  • Dou, Winston Wei
  • Ji, Yan
  • Wu, Wei

Abstract

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.

Suggested Citation

  • Dou, Winston Wei & Ji, Yan & Wu, Wei, 2021. "Competition, profitability, and discount rates," Journal of Financial Economics, Elsevier, vol. 140(2), pages 582-620.
    • Handle: RePEc:eee:jfinec:v:140:y:2021:i:2:p:582-620
    DOI: 10.1016/j.jfineco.2020.12.013
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    More about this item

    Keywords

    Oligopoly; Profitability premium; Leadership persistence; Tariff shocks; Price wars;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • O33 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Technological Change: Choices and Consequences; Diffusion Processes
    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games

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