Research Discussion Papers, Bank of Finland
Market power and merger simulation in retail banking
Abstract: This paper tests market power in the banking industry.
Price-cost margins predicted by different oligopoly models are calculated
using discrete-choice demand estimates of own-price and cross-price
elasticities. These predicted price-cost margins are then compared with
price-cost margins computed using observed interest rates and estimates of
marginal costs. This paper is among the first to apply this methodology on
a detailed, bank-level dataset from the retail banking sector. It extends
on previous papers and illustrates the advantages of structural modelling
by simulating a counterfactual merger experiment with a number of mergers,
each of which involves two major banks, and studying the unilateral effect
of the mergers on interest rates. This provides more evidence that
concentration measures (such as the Herfindahl index) could be very
misleading indicators of market power.
Keywords: demand; discrete choice; product differentiation; banking; market power; merger simulation; (follow links to similar papers)
JEL-Codes: G21; L11; L13; (follow links to similar papers)
26 pages, February 27, 2008
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