Finance Brown Bag Seminar（2016-01）

Topic:Asset Pricing with Endogenous Entry

Speaker:Xiaoquan Wang, Peking University

Time:Friday, 18 March, 12:00-13:00

Location:Room 217, Guanghua Building 2

Abstract:

I build a tractable dynamic stochastic general equilibrium model embedded with endogenous entry. In this economy, successful implementation of heterogeneous production innovations by entrepreneurs contributes to economic growth. Facing barrier to entry, entrepreneurs with products of sufficiently high productivity successfully enter the market. The volatility in the endogenous selection of entrants gives rise to an increase in long-run uncertainty of growth prospects. With recursive preference, the household requires a high risk premium to compensate the long-run risk. The calibrated endogenous entry model can produce an equity premium of 4.08\%, and a low and stable risk-free rate of 0.60%. If I introduce another exogenous shock -- entry shock that fluctuates the barrier to entry, I find an even higher level of equity premium. Moreover, when the entry shock is procyclical, it amplifies the effect of endogenous entry on long-run risk and enhances equity premium. In particular, if the correlation between entry shock and aggregate shock is 0.3, the calibrated equity premium is 5.43%. When I extend the baseline model to incorporate procyclical industrial policies, the extended model quantitatively replicates key features of equity premium and risk-free rate. The model implies that procyclical industrial policies may increase uncertainty about future growth prospects and subsequently raise the cost of equity.

Introduction:

Xiaoquan Wang is a Ph.D. Candidate in Finance at Guanghua School of Management, Peking University. She conducts both theoretical research on asset pricing and empirical studies in corporate finance. Wang holds bachelor degrees in both Statistics and Finance from East China Normal University. She visited Department of Finance at Kellogg School of Management as a pre-doctoral scholar for one year during her Ph.D. study.

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