Endogenous Price War Risks

Winston Wei Dou, Finance, The Wharton School; Yan Ji, Hong Kong University of Science and Technology; and Wei Wu, Mays Business School

Abstract: We develop a general-equilibrium asset-pricing model with dynamic games of price competition. Price war risks arise endogenously from declines in long-run growth as firms’ incentive to undercut prices grows stronger with a worse growth outlook. The triggered price wars have amplification effects by narrowing profit margins. In industries with higher capacity for radical innovation, firms compete more fiercely for future market dominance. Their incentive for price undercutting is less responsive to long-run growth shocks, and they are more immune to price war risks and long-run growth shocks. Our results shed new light on the relationship between competition and equity returns.

Read the full working paper here (PDF).

Michelle Eckert is Marketing and Communications Coordinator for the Mack Institute, where she works to engage students, researchers, and corporate partners in opportunities for collaboration. Michelle received her B.A. in Art from Valparaiso University in 2007. Her background includes two AmeriCorps terms of service working to teach mathematics, computer literacy, and job readiness skills to out-of-school youth in Philadelphia, focusing particularly on promoting access to post-secondary education.