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Product Market Competition, Insider Trading, and Stock Market Efficiency



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    • Joel Peress is with INSEAD, Department of Finance. I thank for helpful comments Patrick Bolton, Philip Bond, Markus Brunnermeier, Murillo Campello, James Dow, Bernard Dumas, Lily Fang, Michael Fishman, Denis Gromb, Charles Jones, Massimo Massa, Jacques Olivier, José Scheinkman, David Thesmar, Laura Veldkamp, Bernard Yeung, and seminar participants at Columbia Business School, HEC Paris, NYU Stern School of Business, Princeton University, HEC Lausanne, the 2007 WFA meeting, Goldman Sachs Asset Management, the 2006 CEPR Summer Symposium in Financial Markets, the 2007 Adam Smith Asset Pricing meeting, the 2008 European Winter Finance Conference (Klosters), and the Caesarea Center 5th Annual Academic Conference. I am also grateful to an anonymous referee and the editor, Campbell Harvey, for many insightful comments and detailed suggestions.


How does competition in firms' product markets influence their behavior in equity markets? Do product market imperfections spread to equity markets? We examine these questions in a noisy rational expectations model in which firms operate under monopolistic competition while their shares trade in perfectly competitive markets. Firms use their monopoly power to pass on shocks to customers, thereby insulating their profits. This encourages stock trading, expedites the capitalization of private information into stock prices and improves the allocation of capital. Several implications are derived and tested.