The Impact of Market Concentration on the Cross-Section of U.S. Stock Returns: An Empirical Analysis

Abstract

This thesis explores the impact of market concentration on the cross-section of U.S. stock returns. It builds upon prior research by Hou and Robinson (2006), who find a significant, negative concentration premium for the period 1963 to 2001. In the former study, investors are compensated for investing in firms and industries that operate in low concentration markets due to their higher innovation and distress risk exposures. As market concentration has increased significantly in recent decades, the impact of market concentration on returns needs reassessment. Therefore, we examine whether a negative concentration premium persists by analyzing U.S. stock returns and industry-averaged returns from 1966 to 2024, with a particular emphasis on the period 2002 to 2024. We reproduce Hou and Robinson’s (2006) methodology by performing Fama-MacBeth regressions controlling for size, book-to-market, momentum, leverage, and post-ranked betas. Thus, we provide novel insights for investors in an increasingly concentrated market landscape. Our findings reveal that the concentration premium observed in prior studies no longer holds when investing in industry portfolios. Innovation risk plays a fundamental role in explaining the revised findings, as we observe structural changes in innovation intensity since the turn of the millennium. In particular, the historical gap in innovation intensity between competitive and concentrated industries has narrowed, leading to the disappearance of the concentration premium. For individual stock returns, however, a significant concentration premium persists, which is not explained by traditional asset pricing factors and does not move with business cycle fluctuations. This can be explained by firm-specific sensitivities to market structure, which are diluted when aggregated at the industry-level. Ultimately, this research contributes to bridging the gap between industrial organization and capital market theory.