Oligopolistic Investment, Markups and Asset-Pricing Puzzles

Abstract

We examine the role of imperfect competition in transmitting aggregate and sectoral shocks to product and asset markets by developing a dynamic multi-consumption good general equilibrium model with an oligopolistic sector that follows subgame perfect capital investment and pricing strategies. Oligopolistic firms strategically adapt investment and production to moderate the effects of shocks on the equilibrium collusive price. Fitting the model to U.S. aggregate and manufacturing industry data, we find support for theoretical predictions on the relation of industry competition with the variability of investment, output, and equity returns, as well as cyclical behavior of markups. The fit of the oligopoly model with varying collusion levels is better than the benchmark competitive industry model. Moreover, because of higher equilibrium volatility of the multi–good consumption bundle, the fit with observed industry equity risk premium, Sharpe ratio, and volatility of returns improves relative to comparable single-good equilibrium models.