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Does market demand volatility facilitate collusion?


  • Wong, Kit Pong


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.

Suggested Citation

  • Wong, Kit Pong, 2008. "Does market demand volatility facilitate collusion?," Economic Modelling, Elsevier, vol. 25(4), pages 696-703, July.
  • Handle: RePEc:eee:ecmode:v:25:y:2008:i:4:p:696-703

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    References listed on IDEAS

    1. Hassan, Shakill, 2006. "Optimal timing of defections from price-setting cartels in volatile markets," Economic Modelling, Elsevier, vol. 23(5), pages 792-804, September.
    2. Robert C. Merton, 2005. "Theory of rational option pricing," World Scientific Book Chapters,in: Theory Of Valuation, chapter 8, pages 229-288 World Scientific Publishing Co. Pte. Ltd..
    3. Kyle Bagwell & Robert Staiger, 1997. "Collusion Over the Business Cycle," RAND Journal of Economics, The RAND Corporation, vol. 28(1), pages 82-106, Spring.
    4. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-887, September.
    5. 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.
    6. 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.
    7. 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.
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    Cited by:

    1. Wong, Kit Pong & Yi, Long, 2013. "Irreversibility, mean reversion, and investment timing," Economic Modelling, Elsevier, vol. 30(C), pages 770-775.
    2. Wong, Kit Pong, 2011. "Progressive taxation and the intensity and timing of investment," Economic Modelling, Elsevier, vol. 28(1-2), pages 100-108, January.
    3. Chu, Kai Cheung & Wong, Kit Pong, 2010. "Progressive taxation and corporate liquidation policies with mean-reverting earnings," Economic Modelling, Elsevier, vol. 27(3), pages 730-736, May.
    4. Wong, Kit Pong, 2009. "Progressive taxation, tax exemption, and corporate liquidation policy," Economic Modelling, Elsevier, vol. 26(2), pages 295-299, March.
    5. Wong, Kit Pong, 2011. "Progressive taxation and the intensity and timing of investment," Economic Modelling, Elsevier, vol. 28(1), pages 100-108.
    6. Wong, Kit Pong, 2010. "The effects of irreversibility on the timing and intensity of lumpy investment," Economic Modelling, Elsevier, vol. 27(1), pages 97-102, January.
    7. Michèle Breton & Mohammed Kharbach, 2015. "Collusion and demand volatility," Economics Bulletin, AccessEcon, vol. 35(1), pages 241-246.
    8. Kit Wong, 2010. "On the neutrality of debt in investment intensity," Annals of Finance, Springer, vol. 6(3), pages 335-356, July.

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