Asset pricing with costly and delayed firm entry

Abstract

Survey evidence tells us that stock prices reflect the risks investors associate with long-run technological change. However, there is a shortage of models that can rationalize long-run risks. Unlike the previous literature assuming a fixed number of products, our model allows for new product varieties that appear in the form of new firms which face entry costs and delay in the entry process. The fixed variety model has a significant limitation in translating macroeconomic volatility into asset return volatility. Our model with growing varieties induces endogenous low-frequency fluctuations in productivity driving large, persistent variations in consumption growth and asset prices. It also changes the valuation of assets through the increase in the volatility of the pricing kernel (with a positive long-run component) and leads to higher excess returns. Our model is motivated by a simple recursively identified VAR model containing quarterly US data 1992Q3-2018Q4 with the following list of variables: total factor productivity, output, a measure of firm entry, and the excess return on stocks.