WORKING PAPER NO. 607 Asset Bubbles and Product Market Competition Francisco Queirós March 2021 University of Naples Federico II University of Salerno Bocconi University, Milan CSEF - Centre for Studies in Economics and Finance DEPARTMENT OF ECONOMICS – UNIVERSITY OF NAPLES 80126 NAPLES - ITALY Tel. and fax +39 081 675372 – e-mail:
[email protected] ISSN: 2240-9696 WORKING PAPER NO. 607 Asset Bubbles and Product Market Competition Francisco Queirós* Abstract This paper studies the interactions between asset bubbles and competition. I first document a negative industrylevel relationship between measures of stock market overvaluation and indicators of market power: larger overvaluation is associated with an increase in the number of firms, lower markups and a higher probability of negative earnings. I then construct multi-industry growth model featuring imperfect competition and rational bubbles that sheds light on these findings. By providing an entry or production subsidy, bubbles stimulate competition and reduce monopoly rents. When they are sufficiently large they can, however, lead to excessive entry and competition. I also show that imperfect competition depresses the interest rate, thereby relaxing the conditions for the emergence of rational bubbles. Keywords: Rational Bubbles, Competition, Market Power, British Railway Mania, Dotcom Bubble JEL Classification: E44, L13, L16 Acknowledgements: I am greatly indebted to my advisors, Fernando Broner and Jaume Ventura, for their guidance and motivation. I also thank Árpád Ábrahám, Vasco Carvalho, Russell Cooper, Matt Delventhal, Alessandro Ferrari, Luca Fornaro, Ramon Marimon, Alberto Martin, Xavier Mateos-Planas, Alessandro Spiganti, Haozhou Tang, TomásWilliams and seminar participants at CREI, EUI, CSEF, the Bank of Spain, the 2018 Transatlantic Doctoral Conference (LBS), the 1st QMUL Economics and Finance Workshop for PhD Students (Queen Mary University), the SED 2018 Annual Meeting (Mexico City), the EEA 2018 Congress (Cologne), and the SMYE 2019 (Brussels) for helpful discussions and suggestions.