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Testing the Pricing-to-Market Hypothesis: Case of the Transportation Equipment Industry

  • Khalaf, Lynda
  • Kichian, Maral

Pricing-to-market (PTM) theory suggests that monopolistic firms which export adjust their destination-specific markups in reaction to exchange rate shocks. These adjustments limit changes in the price of their exports. Thus, important movements in the bilateral nominal exchange rate between two countries that trade are not necessarily fully reflected in the price of imports. Evidence in favour of PTM has been mostly obtained through hypothesis testing on the OLS, instrumental variable (IV), or single-equation error-correction estimates of partial-equilibrium models. However, we know from the recent econometric literature that Wald tests applied to some of these estimates may give erroneous results in the presence of endogeneity and weak instruments. In this paper, we examine the reliability of the evidence supporting the hypothesis of pricing-to-market using LIML-based LR Monte Carlo tests. These tests, developed by Dufour and Khalaf (1998), have good power and, unlike the Wald test, also have the correct test size. We find that the size-correct Monte Carlo LR-based test reverses half of the results obtained from the popular Wald test, indicating that PTM may not be as widespread as previously believed. In addition, our results support the view that PTM behaviour is likely to be present in the same industry across different countries and that pass-through is possibly higher with a larger market share of exports. The above findings are illustrated using the model developed by Marston (1990) and our analysis is conducted for export pricing firms in the transportation equipment industry for three country pairs: Canada exporting to the United States, the United States exporting to Canada, and Japan exporting to (mainly) the United States.

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Paper provided by Bank of Canada in its series Staff Working Papers with number 00-8.

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Length: 35 pages
Date of creation: 2000
Date of revision:
Handle: RePEc:bca:bocawp:00-8
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  1. Hamid Faruqee, 1995. "Pricing to Market and the Real Exchange Rate," IMF Working Papers 95/12, International Monetary Fund.
  2. Feenstra, Robert C., 1989. "Symmetric pass-through of tariffs and exchange rates under imperfect competition: An empirical test," Journal of International Economics, Elsevier, vol. 27(1-2), pages 25-45, August.
  3. Thomas Klitgaard, 1999. "Exchange rates and profit margins: the case of Japanese exporters," Economic Policy Review, Federal Reserve Bank of New York, issue Apr, pages 41-54.
  4. Laurence Ball, 1998. "Policy Rules for Open Economies," NBER Working Papers 6760, National Bureau of Economic Research, Inc.
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  7. Feenstra, R.C. & Gagnon, J.E. & Knetter, M.M., 1993. "Market Share and Exchange Rate Pass-Through in World Automobile Trade," Papers 93-14, California Davis - Institute of Governmental Affairs.
  8. Betts, Caroline & Devereux, Michael B., 1996. "The exchange rate in a model of pricing-to-market," European Economic Review, Elsevier, vol. 40(3-5), pages 1007-1021, April.
  9. Pinelopi Koujianou Goldberg & Michael M. Knetter, 1997. "Goods Prices and Exchange Rates: What Have We Learned?," Journal of Economic Literature, American Economic Association, vol. 35(3), pages 1243-1272, September.
  10. Kasa, Kenneth, 1992. "Adjustment costs and pricing-to-market theory and evidence," Journal of International Economics, Elsevier, vol. 32(1-2), pages 1-30, February.
  11. Davidson, Russell & MacKinnon, James G., 1993. "Estimation and Inference in Econometrics," OUP Catalogue, Oxford University Press, number 9780195060119, December.
  12. Douglas Staiger & James H. Stock, 1997. "Instrumental Variables Regression with Weak Instruments," Econometrica, Econometric Society, vol. 65(3), pages 557-586, May.
  13. Peter Hooper & Catherine L. Mann, 1989. "Exchange Rate Pass-through in the 1980s: The Case of U.S. Imports of Manufactures," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 20(1), pages 297-337.
  14. Giovannini, Alberto, 1988. "Exchange rates and traded goods prices," Journal of International Economics, Elsevier, vol. 24(1-2), pages 45-68, February.
  15. Joseph E. Gagnon & Michael M. Knetter, 1992. "Markup Adjustment and Exchange Rate Fluctuations: Evidence From Panel Data on Automobile Exports," NBER Working Papers 4123, National Bureau of Economic Research, Inc.
  16. Marston, Richard C., 1990. "Pricing to market in Japanese manufacturing," Journal of International Economics, Elsevier, vol. 29(3-4), pages 217-236, November.
  17. Cheung, Yin-Wong & Chinn, Menzie & Fujii, Eiji, 2001. "Market Structure and the Persistence of Sectoral Real Exchange Rates," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 6(2), pages 95-114, April.
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