Capital Investment, Equity Returns, and Aggregate Dynamics in Oligopolistic Production Economies

Abstract We analyze effects of tacit collusion in a dynamic general equilibrium model of oligopolistic sectors with capital investment and real frictions. Through their effects on equilibrium- and off- equilibrium stock prices, fundamental shocks affect incentives for defection from tacit collusion, amplifying the interaction between the real economy and financial markets as well as firms‘ risk exposure. The model implies ambiguous relationship between industry concentration and equity returns depending on operating leverage, which helps reconcile conflicting evidence in the literature. We find quantitative and empirical support for novel theoretical predictions regarding the effects of concentration on returns and investment. (JEL G12, G31, D43)