Asset Pricing with Entry and Imperfect Competition

Abstract

I study the implications of uctuations in new firm creation across industries for asset prices and macroeconomic quantities. I write a general equilibrium model with heterogeneous industries, allowing for firm entry and time variation in markups. Firms entering an industry increase competition and displace incumbents' monopoly rents. This mechanism is strongest in industries that exhibit high profit margins and high elasticity of innovation to the cost of entry. A positive shock to the aggregate cost of entry increases the marginal utility of consumption |the price of entry risk is negative. Therefore, firms with more exposure to rents' displacement have higher expected excess returns. Using micro-level data on entry rates, I trace out the impact of firm creation on incumbent firms' profitability and stock returns. The effect is strongest for the types of industries the model predicts. I confirm aggregate entry risk is priced: differential exposure to the aggregate entry shock explains a large fraction of the cross-industry variation in expected returns.