Description:

Speaker: Kevin Ren

Title: Market Power, Expectations, and Asset Prices

Abstract: Asset pricing has shifted focus from discount-rate variation to subjective expectations of long run profit growth. The deviation from full-information rational expectations is able to explain a large portion of the variation in asset returns. This shift makes it essential to understand what drives these expectations in profits. Profit growth is anchored in market power: the ability to set prices above marginal cost in product markets or to pay wages below the marginal revenue product of labor in input markets. Using the U.S. Census Longitudinal Business Database (LBD) and analyst forecast data, we show that expectation distortions and return predictability varies with the degree of product and labor market power: high labor market power dampen predictability, while high product market power amplify and prolong distortions. Embedding these heterogeneities in a simple diagnostic expectations macro-finance model, we match key asset-pricing moments without discount rate variation and show that distorted expectations interacting with market power generate pronounced, procyclical misallocation.