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Estimating market power in homogenous product markets using a composed error model: application to the California electricity market

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  • Orea, L.
  • Steinbuks, J.

Abstract

This study contributes to the literature on estimating market power in homogenous product markets. We estimate a composed error model, where the stochastic part of the firm’s pricing equation is formed by two random variables: the traditional error term, capturing random shocks, and a random conduct term, which measures the degree of market power. Treating firms’ conduct as a random parameter helps solving the issue that the conduct parameter can vary between firms and within firms over time. The empirical results from the California wholesale electricity market suggest that realization of market power varies over both time and firms, and reject the assumption of a common conduct parameter for all firms. Notwithstanding these differences, the estimated firm-level values of the conduct parameter are closer to Cournot than to static collusion across all specifications. For some firms, the potential for realization of the market power unilaterally is associated with lower values of the conduct parameter.

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Bibliographic Info

Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 1220.

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Date of creation: 25 Apr 2012
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Handle: RePEc:cam:camdae:1220

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Web page: http://www.econ.cam.ac.uk/index.htm

Related research

Keywords: market power; random conduct parameter; composed error model; asymmetric distributions; California electricity market;

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  1. Peter Schmidt & Antonio Alvarez & Christine Amsler, 2004. "Interpreting and testing the scaling property in models where inefficiency depends on firm characteristics," Econometric Society 2004 Far Eastern Meetings, Econometric Society 520, Econometric Society.
  2. Grigorios Emvalomatis & Spiro E. Stefanou & Alfons Oude Lansink, 2010. "A Reduced-Form Model for Dynamic Efficiency Measurement: Application to Dairy Farms in Germany and The Netherlands," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, Agricultural and Applied Economics Association, vol. 93(1), pages 161-174.
  3. Corts, Kenneth S., 1998. "Conduct parameters and the measurement of market power," Journal of Econometrics, Elsevier, Elsevier, vol. 88(2), pages 227-250, November.
  4. Karen Clay & Werner Troesken, 2003. "Further Tests of Static Oligopoly Models: Whiskey, 1882-1898," Journal of Industrial Economics, Wiley Blackwell, Wiley Blackwell, vol. 51(2), pages 151-166, 06.
  5. Natalia Fabra & Juan Toro, 2002. "Price Wars and Collusion in the Spanish Electricity Market," Industrial Organization, EconWPA 0212001, EconWPA, revised 31 Aug 2003.
  6. Appelbaum, Elie, 1982. "The estimation of the degree of oligopoly power," Journal of Econometrics, Elsevier, Elsevier, vol. 19(2-3), pages 287-299, August.
  7. Severin Borenstein & James Bushnell & Christopher R. Knittel & Catherine Wolfram, 2008. "INEFFICIENCIES AND MARKET POWER IN FINANCIAL ARBITRAGE: A STUDY OF CALIFORNIA'S ELECTRICITY MARKETS -super-* ," Journal of Industrial Economics, Wiley Blackwell, Wiley Blackwell, vol. 56(2), pages 347-378, 06.
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