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.
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.:
- Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-887, September.
- 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.
- 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.
- 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..
- Robert C. Merton, 1973. "Theory of Rational Option Pricing," Bell Journal of Economics, The RAND Corporation, vol. 4(1), pages 141-183, Spring.
- Kyle Bagwell & Robert Staiger, 1997. "Collusion Over the Business Cycle," RAND Journal of Economics, The RAND Corporation, vol. 28(1), pages 82-106, Spring.
- 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.
- Bagwell, K. & Staiger, R.W., 1995. "Collusion Over the Business Cycle," Working papers 9504, Wisconsin Madison - Social Systems.
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 references are entirely missing, you can add them using this form.