Does market demand volatility facilitate collusion?
This paper develops a real options model of a price-setting cartel under uncertainty to examine whether market demand volatility facilitates collusion or not. We show that there is a critical level of market demand (the optimal defection trigger) above which firms find it desirable to defect from the cartel. We show further that an increase in the underlying market demand uncertainty has two opposing effects on the optimal defection trigger. First, the increased market demand volatility gives rise to the usual positive effect on option value that lifts up the optimal defection trigger. Second, the increased market demand volatility calls for an upward adjustment of the discount rate and thus creates a negative effect on option value that pushes down the optimal defection trigger. We show that the negative effect dominates (is dominated by) the positive effect when the underlying market demand uncertainty is trivial (significant), thereby rendering a U-shaped pattern of the optimal defection trigger against the market demand volatility.
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Hassan, Shakill, 2006.
"Optimal timing of defections from price-setting cartels in volatile markets,"
Elsevier, vol. 23(5), pages 792-804, September.
- Shakill Hassan, 2005. "Optimal timing of defections from price-setting cartels in volatile markets," Working Papers 03, Economic Research Southern Africa.
- Robert C. Merton, 1973.
"Theory of Rational Option Pricing,"
Bell Journal of Economics,
The RAND Corporation, vol. 4(1), pages 141-183, Spring.
- Bagwell, K. & Staiger, R.W., 1995.
"Collusion Over the Business Cycle,"
9504, Wisconsin Madison - Social Systems.
- Kyle Bagwell & Robert W. Staiger, 1995. "Collusion Over the Business Cycle," Discussion Papers 1118, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
- Kyle Bagwell & Robert W. Staiger, 1995. "Collusion over the Business Cycle," NBER Working Papers 5056, National Bureau of Economic Research, Inc.
- Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-887, September.
- Wong, Kit Pong, 2007. "The effect of uncertainty on investment timing in a real options model," Journal of Economic Dynamics and Control, Elsevier, vol. 31(7), pages 2152-2167, July.
- Plourde, André & Watkins, G. C., 1998. "Crude oil prices between 1985 and 1994: how volatile in relation to other commodities?," Resource and Energy Economics, Elsevier, vol. 20(3), pages 245-262, September.
- Robert McDonald & Daniel Siegel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, Oxford University Press, vol. 101(4), pages 707-727.
When requesting a correction, please mention this item's handle: RePEc:eee:ecmode:v:25:y:2008:i:4:p:696-703. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dana Niculescu)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.