Product Variety and Asset Pricing

We develop a general-equilibrium multi-industry model with endogenous product variety and study its implications for asset prices. We estimate the model with both the Generalized Method of Moments (GMM) and the Simulated Method of Moments (SMM) and show that the equity premium and risk-free rate are consistent with empirically reasonable risk aversions and discount factors. The market risk premium increases significantly with the interindustry product complementarity. The model also generates the additional novel predictions that the market risk premium increases with the intraindustry product substitutability, and that industries with more substitutable products have higher excess returns. We show support for these implications in our empirical analysis.

This paper was accepted by Agostino Capponi, finance.

Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2024.05040.