We present a new log-linear identity that relates a firm's market value to future markups, output growth, discount rates, and investment in a present-value framework. Expected markups are a dominant contributor to variation in firm values and to the rise in the aggregate market value of U.S. public firms since the 1980s. The rise in aggregate expected markups is driven by reallocation of market share towards higher-markup firms, echoing results for realized markups. Expressing markups in terms of a forward-looking value component rather than realized markups reveals that this reallocation has recently been accelerated by mergers involving highly-valued, high-markup target firms. Expected markups are closely tied to expected fixed costs and investments, including investments in intangibles. We find a a negative time-series relationship between expected markups and discount rates rates, but a positive cross-sectional link to risk premia after accounting for other risk factors, thus reconciling risk-based arguments with theories tying the rise in market power to the fall in interest rates.

I demonstrate that the preference by asset managers to diversify stocks and follow certain investment mandates result in forecastable contrarian trading on their largest positions. Since large-cap stocks are held in similar positions across most asset managers, few equity portfolios are available to absorb this predictable source of demand. The large stock portfolios during the sample period (Q1 1990 to Q2 2021) exhibit a novel return-reversal pattern that is consistent with this demand channel. A variable that forecasts this source of demand for large stocks can explain return reversals in the momentum portfolios formed from the largest US companies.

This paper explores the asset pricing implications of a granular economy, where a few firms are exceedingly large (the size of ’grains’). We present three new findings that support the idea that a more granular economy may be detrimental to investors, due to reduced diversification across stocks and heightened aggregate risk. First, the slope of the Security Market Line (SML) exhibits a negative relationship with the level of granularity. Second, the betting-against-beta (BAB) strategy performs well only during times of increased granularity, aligning with the SML’s decreasing slope. Third, exposure to granularity is negatively priced, indicating that stocks performing well during increased granularity offer protection against diversification risk, thereby providing lower returns. These results underscore the critical role of granularity in understanding vital aspects of equity markets.