“Competition, Markups, and Predictable Returns” by Howard Kung
University of British Columbia
London Business School
Imperfect competition is an important channel for time-varying risk premia in asset markets. We build a general equilibrium model with monopolistic competition and endogenous firm entry and exit. Endogenous variation in industry concentration generates countercyclical markups, which amplifies macroeconomic risk. The nonlinear relation between the measure of firms and markups endogenously generates countercyclical macroeconomic volatility. With recursive preferences, the volatility dynamics lead to countercyclical risk premia forecastable with measures of competition. Also, the model produces a U-shaped term structure of equity returns.